Your home will most probably be the biggest investment you will make, and finding out how much you can comfortably afford is vital. Do you want to buy your home and have your family to have a miserable life because you took on a financial obligation you cannot manage? You probably have other investments you are making besides purchasing a house. So, draft a budget and make sure that you know how much you can afford before rushing to buy a house. The good thing is preparing a home budget is easy, and it will not take much of your time with the help of a Smart Mortgage Advisor. Remember, every mortgage relies on proper financing plans, and you should take a real estate value within your budget.
What is mortgage affordability?
Affordability is the proportion of the continuing financing expenses of a real estate to your income. The standard rule for the affordability of home loans is that the costs should not go beyond one-third of your gross income. The expenses are:
- Mortgage interest rate
- Property maintenance costs
- The set loan amortization amount
- Insurance premiums
If the ratio exceeds one-third, most lenders term the loan unaffordable. It is uncertain whether you will be able to pay the interest charges and comply with the loan amortization schedule. None the less, some lenders will give home loans despite the property costs exceeding one-third of your gross earnings.
Using our affordability calculator, it will be easy to find the home affordability. The calculator presumes a 5% interest rate, which most lenders apply. The rate also applies in better actual market conditions when the interest is in a low phase. Banks employ a pessimistic calculation approach to hedge against increasing mortgage rates. This leads to variable rate and LIBOR mortgages getting costlier over the loan term. The calculated interest rate may also go down by 0.5% to 1% from time to time.
Incomes and Home Affordability Assessment
Lenders view income situations differently from case to case. Sometimes they can include earnings that are not part of your fixed salary and cannot be assured in the future. They can also take into account the life situations of the borrowers when assessing affordability. For instance, when evaluating a young couple, banks consider the possibility of one parent not being able to work for some time due to childbearing. This could affect their joint earnings. When it comes to the evaluation of a second mortgage loan, the assessment requirements are tighter.
It is usually vital to get different mortgage offers from different lenders. This helps take care of situations where one bank declines to take your partner’s income contribution into account. Another bank may accept to include the source of income without any restrictions.
How Much Can I Afford on a house?
To ensure that you will still afford the mortgage you commit to now, do not get carried away by the vast amount the bank is offering you. Estimate your repayments and consider all possible situations that could affect your ability to pay the mortgage.
Using our home affordability calculator input the following figures to come up with your home-buying budget:
- Start your budget by establishing what you and your partner, if applicable, earns every month. Add all incomes from your salaries and bonuses to the earnings from other investments.
- Put down all the housing expenses, including the down payment. On the list add property tax, assumed mortgage interest rate, homeowner’s insurance charges, and the length of time you would want to pay off your loan.
- Add up all your monthly expenses. Ensure the costs are as accurate as possible.
The 28/36% Rule
Leveling off your earnings to purchase your dream house is the surest way to get yourself in a financial crisis. When coming up with your home buying budget, remember to give room for unexpected expenses and emergencies. You also should factor in your retirement savings plans. If you are stuck with how much can I afford for house question, the 28/36% rule will help you out. We advise you not to spend more than twenty-eight percent of your gross monthly income on housing costs, and you should not exceed thirty-six percent on cumulative debts. The 26/36% rule helps form a baseline for what you can comfortably manage to pay monthly.
Depending on your monthly spending habits, your annual earnings can either be more than enough to take care of a mortgage of insufficient. Having an idea of what you can afford without straining helps you make very informed and sound financial decisions. Getting a 30-year home loan is easy, but it might be too expensive for your budget and other financial plans.
How to Get The Best Interest Rate
It is sensible to look for a low-interest rate since it can help you save a lot over your loan. Lenders are known to give lower rates to people with high credit scores, reasonable down payments, and smaller existing debts.
- Credit score
It is always wise to put your credit standing right before applying for a mortgage. Ensure that you check your credit report with credit reference agencies, evaluate the report, and check if there are any mistakes. If you come across any incorrect information on your report, notify the agency immediately. Note that you will have to prove the errors by giving evidence. For identity fraud, ensure that you file a fraud case with your local police unit.
- Debt to income ratio
The debt to income (DTI) ratio equates your monthly income to your debts. If you have a lower debt relative to your earnings, you will have a lower debt to income ratio and vice versa. The ratio is essential since it helps the lender to know your ability to take up more debt obligations. The lower your DTI is, the easier it will be for you to get a home loan. It will also be much easier for you to negotiate for a reasonable interest rate. Most banks do not lend to a person with a debt to income ratio of more than 43%.
To qualify for a mortgage with a lower interest rate, try and pay off existing loans, and make room for more manageable payment of your mortgage. Reducing your credits allows you to manage your monthly expenses and gives you and an easy time taking care of emergency expenses that may arise.
How to come up with your DTI
When calculating your DTI do not include monthly costs since it is only debt obligations that are evaluated. Add up all your monthly debt requirements and divide the amount by your gross monthly income, that is, your earnings before taxes and other deductions.
- Down payment
The more the down payment you make for a mortgage, the lower the interest rate you will get since lenders are risking less money. The down payment you make is used to calculate the loan to value (LTV) ratio. The larger the down payment, the lower the loan to value ratio, and the lesser the risk your lender will take up.
You might not have saved up a significant down payment by the time you are ready to buy your property, but you can later get a lower rate refinancing with a favorable market state. When your down payment is low, ensure that your finances and credit score is high to get your refinancing at a good rate. The sooner you manage to get a lower rate, the quicker you will be able to reduce your monthly mortgage payments.
Practically, it is not always easy to save up a significant down payment, but there are assistance programs to help buyers with little or no down payments. Consult with your mortgage advisor to help you get the first-time homebuyer, government, or needs-based down payment assistant programs you are eligible for.
Changing circumstances to consider when calculating your mortgage affordability
A home loan can dictate most of the choices you will make because of the repayment obligation. As you apply for a mortgage, create a buffer for you to be flexible, and prevent the repayments from dictating your life. Areas to make plans for:
- Your family- with children, there are so many emergencies that create extra expenses. There is a possibility of you living in one income instead of two for some time.
- Career- you could be making plans to go back to study to enhance or change your career. Factor in the effect which the decision will have on your current earnings.
- Interest rate changes- mortgages with fixed rates remain the same for the life of the loan, but those with variable rates keep shifting with changes in the real estate market. Lenders evaluate your ability to pay your mortgage at a higher rate to determine how much they can give you. However, before taking on the offer, it is right for you to be sure how comfortable you will be with your monthly payments if the rates go up.
- Safety requirements- expenses such as homeowners’ insurance can increase your monthly payment obligations. However, it gives you an assurance and confidence that you will make your monthly payments regardless of the changes that may come your way.
- Repairs and renovations- when using our mortgage affordability calculator, make sure to factor in renovation expenses under your housing costs and make plans how you will finance them.
- Are you ready to get started? Get help with your home loan from our advisors at Smart Mortgage Center. When applying for a mortgage, it is essential to check out various types of home loans available and select what supports your needs. Ensure that you are realistic about your expenses, and the amount you borrow is within your budget and financial goals. Remember, home buying obligations do not begin or end with a mortgage.