Are you unsure about whether you can afford to buy a home? Are you pretty confident you can buy a home but unsure of how much home you could afford? Are you unsure about where to even start when you want to buy a home? Headlines suggest homes have become affordable for most Americans and there’s hard evidence that shows owning a home is more affordable than renting in most parts of the country. Here in the Charleston market, record-low interest rates are keeping monthly mortgage payments about 23% lower than the typical payment of 20 years ago.
In a recent survey by Realtor.com, home shoppers indicated they were surprised by what they could actually afford when buying their first home. In fact, 47% discovered their budget was larger than they expected. George Ratiu, Senior Economist at Realtor.com, explains: "For first-time buyers, especially, the drop in the 30-year mortgage rate…has provided unexpected leverage. Lower rates allowed many buyers to stretch and buy more expensive homes while keeping their monthly budget the same."
This is all great information, but what does it mean for you? This article will go over the basics of understanding what type of home you'll be able to afford.
Does My Salary Affect What Homes I Can Afford?
While there are a number of factors that affect how much you can afford to spend on the purchase of your home - your salary and that of your partner does factor into what homes are available to you. However, a high salary doesn't automatically mean a higher-priced home is feasible. In fact, it's possible someone with a lower salary could qualify for more - It all has to do with debt.
How Does My Debt-to-Income Ratio Affect What I Can Afford?
Your debt-to-income ratio (or DTI) will be considered by your mortgage lender if you're applying for a home loan. DTI is the total monthly payments you're making toward debts divided by your gross monthly income. The debts they consider include things like your student loans, car loans, credit card debt, etc.
You may have heard of the 28/36 rule before which lenders use to determine your DTI. Lenders want to see that you're not going to be spending more than 28% of your gross monthly income on your mortgage and no more than 36% on debt payments. It's possible if your DTI is higher than the 28/36 rule, lenders can still approve you for financing but you'll be dealing with higher interest rates and additional costs like mortgage insurance that protects the lender, but adds up to higher costs for you.
In addition, the 28/36 rule could mean qualifying for a larger loan amount, but that's not always the best option. Let's look at some ways to make sure you're making the best decisions.
How Do I Calculate How Much Home I Can Afford?
We've found in quite a few cases that our clients have been surprised by how much they actually qualify for. Here are a few pointers to help you figure out how much home you can afford yourself.
Use the 25% Rule
One of the easiest ways to calculate how much house you can afford is by using the 25% rule. This ensures you never spend more than 25% of your after-tax income on monthly mortgage payments. This number includes principal, interest, property taxes, home insurance PMI and HOA fees so keep that in mind.
For example, if your monthly after-tax income is $5500, that would mean you should spend no more than $1,375 on your monthly house payment to include all the fees mentioned above.
Experts say if you stick with this number (Instead of the 28/36 rule) you'll give yourself plenty of wiggle room to save for other expenses that may pop up. In contrast, using the 28/36 rule could give you approval for a much higher loan amount, but you may find yourself house poor by having nothing left over each month after paying the costs associated with your mortgage. If you're a single mother figuring out how to buy a home, the 25% rule is a great tip to help keep your finances in check and keep that emergency fund topped up.
Aim for 20% Down
Paying all cash for your home will always be ideal if you want zero mortgage payments but most people don't have hundreds of thousands of dollars sitting to the side - so for most people, a mortgage is the typical path home buyers will take and the industry standard is 20% down.
In addition to your income and DTI, the amount of downpayment you're able to make will affect your mortgage. If you're unable to bring 20% to the table, your costs will rise. Typically, you'll need to pay private mortgage insurance which can run up to 1% of your loan amount until you've built 20% equity in your home. 20% down will help to prevent the additional cost of mortgage insurance.
Don't Forget Closing Costs and Other Expenses
Closing costs are around 3-4% of the purchase price of your home so it's important to remember those expenses will be part of your home purchase as well. Closing costs cover things like appraisal fees, credit reports, home inspections, and closing attorneys - all important parts of the home buying process you can't avoid.
It's Still More Affordable to Buy a Home Right Now
For example, here’s the typical mortgage payment for assorted dates going back to 2000, as calculated by CoreLogic: Outside of the housing crash (when short sales and foreclosures drove prices down), it’s more affordable to buy a home today when you consider all three elements of the affordability equation: price, income, and mortgage rate.
Try This Free Mortgage Calculator To See How Much Home You Could Afford
We've got a quick and easy way to estimate how much home you may be able to afford. Our mortgage calculator allows you to enter your information to get a general estimate of costs. Give it a try!
Final Thoughts on Home Affordability
Whether you’re a first-time buyer or a move-up buyer, don’t automatically think you are not able to buy your dream home before you even try; Instead, connect with us today to determine what you can afford and what’s available at that price. Like almost half of the buyers in the survey and many of the buyers that we work with, you may be pleasantly surprised.
