This is Part 2 in a series of posts about how to tackle the home buying process.
How much house can you afford? Your income is of course the main factor in affordability, but figuring out exactly what that means can seem tricky.
In reality, it comes down to one number – 43%. This is the debt-to-income ratio limit that lenders look at to ensure you will be able to repay your loan. In other words, all of your monthly payments (mortgage, HOA, car, student loans, credit cards) should not exceed 43% of your monthly income (before taxes).
Let’s assume you make $60,000/year.
Your gross monthly income before taxes is $5,000.
$2,150 (43%) can go towards all your debts.
Now assume you have a $300 car payment and a $25 minimum credit card payment each month.
$1,825 is the remaining amount that can be used towards your mortgage, insurance and HOA expenses.
Assuming $300/month in HOA dues, the current 4% interest rate, and a 20% down payment, you can afford a $300,000 home on a $60,000 salary in this scenario.
A smaller down payment or higher interest rate will lower the amount of home you can afford, but good credit and certain loan programs can allow you to go above the 43% debt-to-income ratio, increasing the amount you can afford.
This affordability calculator is a great tool to help estimate what you can afford in your specific situation. Jump to the “Affordability” button at the top of the page and play around with different scenarios.
Stay tuned for next week’s post which will discuss what you need to have saved for a purchase.