How Much Can I Afford?
Now, This One Is a Loaded Question!
While these are some guidelines on what lenders will require, the final answer of what you can afford rests with you. The reason for this is that every borrower is different, and each one has a different set of financial circumstances. One borrower may have additional income that is not being considered by his/her spouse. Another borrow may have a high level of expenses that are not considered by a lender (like education or utility expenses).
But from a lenders perspective, assuming all income is accounted for, and there are no major expenses outside of what is shown on your credit report, here is how they will look at it. Your total housing expense will include a mortgage payment, property taxes, home insurance, mortgage insurance (if applicable), and HOA dues (if applicable). Add up the monthly equivalent of all those related items. That amount, divided by your “gross” income is what we call your housing ratio. Different loan products will require different housing ratios. For sake of simplicity, let’s call it 40% of your income.
Your Total Debt Ratio
Additionally, the lender will look at your total debt ratio, which is simply your housing expense (as calculated above) added to your total consumer debt payments (like car payments, student loan payments, credit card payments, etc…). This combine number, divided by your gross income, will result in your “total debt ratio”. Again, different loan types will allow for a higher or lower debt ratio. But for simplicity, let’s keep that ratio under 45%.
So now it is simple math. If you take your gross income, and multiply it by 45%, that will give you your maximum monthly expenses. Let’s call your income $10,000 per month. That means your total expenses cannot exceed $4,500 ($10,000 multiplied by 45%). If you have $500 per month in car payments and credit card payments, that will leave you with $4,000 that can go towards your housing costs ($4,500-$500).
Ready to Talk to a Lender?
This is where you need help from a professional mortgage consultant. Your housing expense needs to include property taxes, insurance, etc…. So it is not simply a reverse calculation of the mortgage payment. Lastly, because of the different types of loans, and their respective debt ratio requirements, and the differences from one borrower to another, it is time to talk to a lender.