Purchasing a home is one of the most significant financial commitments anyone will make. So, determining how much you can comfortably afford to spend on a home is one of the key steps in the homebuying process.
It is rare for homebuyers to have the cash on hand to purchase a home, so most homebuyers get a mortgage loan. Mortgage lenders will determine how much of a mortgage loan you qualify for. However, just because you are approved for a certain amount does not mean you should purchase a home that costs that much.
Read on for more information and tips to help determine how much you can afford to spend on a mortgage.
Factors that Determine How Much You Can Afford to Spend on a Home
Many important factors come into play when determining how much you can afford to spend on a home, such as your income or debt-to-income ratio, credit score, and more.
Your income is an apparent factor in how much you can afford to spend on a home. The more money you make, the more you can afford to spend. However, it is crucial to consider how much of your income is already being dispersed to other debts you may have.
When getting a mortgage loan, mortgage lenders will want to know how much debt you have and how long you will be making payments on that debt. Whether you have car loan payments, student loans, or other personal loans, mortgage lenders will factor those in to determine how much you can afford to spend on a mortgage loan.
Mortgage lenders consider your debt-to-income ratio (or DTI) a crucial qualifying factor, as they do not want you to be able to pay your mortgage payment. Therefore, it is crucial to understand your debt-to-income ratio. Here is how to calculate your DTI:
#1 Calculate your monthly debts. Your monthly debts can include the following:
- Monthly house or rent payments.
- Child support payments or alimony.
- Student loan payments.
- Credit card payments.
- Car Payments.
#2 Divide your monthly debts by your monthly gross income.
If your debts add up to $2,000 per month and your monthly gross income (before tax) is $8,000 per month, then your DTI ratio is .25 or 25%.
The larger the down payment, the lower your monthly payment, meaning the more house you can afford.
If you put 20% down, you will not have to pay mortgage insurance, which can free up more cash to put toward the principal and interest on your mortgage loan.
It is important to note that you may not have to make a down payment if you qualify for certain government loans.
Credit scores are the foundation of finances and play an essential role in determining your mortgage rate. Borrowers with high credit scores are typically offered lower interest rates, while those with lower ones are offered more expensive interest rates.
Credit scores are also a factor that determines the mortgage loans you qualify for. In addition, credit scores significantly affect how much you can afford to spend on a home.
Type of Home Loan
The type of home loan you choose to apply for can affect how much you can afford to spend on a home. Here are some mortgage loan options:
- VA loan: VA loans are available to United States veterans and service members. They do not require down payments or have credit score requirements.
- FHA loan: FHA loans are backed by the Federal Housing Administration and are great for those with a lower credit score and less money for a down payment.
- Conventional loan: Conventional loans allow borrowers to purchase a home with as little as 3% down.
- USDA loan: USDA loans are backed by the U.S. Department of Agriculture, and borrowers can qualify for this type of loan if they are interested in buying property in a qualified rural or suburban area. This type of loan is excellent for those with low-to-moderate income.
- Jumbo loan: Home loans that exceed the Federal Housing Agency’s (FHA) limits.
Extra Costs to Consider When Determining How Much You Can Afford to Spend on a Home
Purchasing a home comes with many additional expenses. Along with taking out a mortgage loan, it is crucial to consider other costs such as utilities, home maintenance, homeowner association fees, living expenses, and additional insurance that may be required for your new home.
It is crucial to consider the extra costs when budgeting to determine how much you can afford to spend on a home.
Closing costs must be paid during the closing, the last step in the homebuying process. Closing costs typically range from 2%-6% and can include expenses such as title search fees, credit report charges, appraisal fees, and more.
Occasionally, sellers will pay for closing, but it is always a good idea to be prepared if you are required to pay closing costs.
If you own a property, you must pay property taxes, which are assessed by the property’s county assessor and multiplied by the local tax rate.
To get an idea of how much the property taxes will be, you can contact your local tax assessor to get more information.
Homeowners insurance covers the damage on a home in the event of a storm or crime. A local insurance agent could give you a monthly estimate.
Homeowners Association Fees (HOA)
If you are purchasing a property in a neighborhood, there is the possibility that the area requires HOA fees. These fees can be monthly or yearly, but adding HOA fees to your monthly budget is crucial.
HOA fees can vary depending on how much upkeep the neighborhood requires or how many amenities the community has, such as a community pool or playground.
Once you purchase a home, it is essential to have the funds to maintain the upkeep of the home or fix things such as electrical or plumbing issues.
Maintenance on a home will vary depending on the home’s age, but even a newly constructed home will require an investment for upkeep.
The utilities of your new home may cost more than your previous home. The electricity or water bill may be slighter higher, and financially, it is crucial to consider the potential increase in bills in your budget.
Tips for Purchasing a Home
It is important to note that even though your mortgage lender is willing to loan you a considerable amount, it does not mean you have to borrow the entire amount if it causes financial strain.
Here are a few more tips to remember when purchasing a home.
Be Prepared for Emergencies
Emergencies happen when you least expect them. Having an emergency fund can alleviate any financial stress, whether job loss, medical expenses, car trouble, or a significant water leak.
Instead of putting all your extra money towards mortgage payments, setting aside money each month can bring homeowners peace of mind in an emergency.
Be Prepared for Changes in Employment
There is always a chance that you could lose your job. Paying your mortgage will become more challenging or even impossible if job loss occurs.
We specialize in conventional home mortgages, FHA, VA, and USDA mortgage options, refinance loans, and reverse mortgages. We’ve worked extensively with cash-out refinancing and help clients to lower their monthly mortgage payments.