How much should my mortgage be?
The main thing that you and your lender should be concerned about is not the total mortgage amount. Instead, you should focus on the monthly mortgage payments and whether you can easily afford it.
Lenders use your debt ratio (DTI) as a measure of affordability. And they consider a 36% DTI to be excellent.
Ideally, this means that your monthly debt, including the mortgage payment, does not exceed 36% of your monthly income. But lenders can be flexible, so if your DTI is a bit higher, don’t worry.
The trick is to find the loan amount and mortgage program that is right for you. Here’s how.
Check your mortgage eligibility (April 26, 2021)
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Mortgage payments and income
Your mortgage should be an amount that you can easily afford within your monthly budget. So, when figuring out the right loan size, you have to work backwards – find the right monthly payment first and calculate the price of the house based on that number.
When it comes to monthly payments, just one number is key in determining what you can afford: your debt-to-income ratio.
Of course, other factors also matter, such as your credit score, your mortgage rate and your down payment.
But DTI has a huge impact on accessibility. It is therefore important to understand how mortgage lenders view this figure.
What is your debt ratio (DTI)?
Your DTI is the percentage of your gross monthly income (before tax) that you spend on unavoidable financial obligations – in other words, on debt.
This includes payments on your new home, minimum payments on credit cards, fixed payments on auto loans, student loans, and other loans, and things like alimony and child support.
But your DTI does do not include discretionary spending. Therefore, you should not include expenses for groceries, gas, utilities, food, cell phone and internet, and any other expenses that you can control each month.
How DTI Affects Your Mortgage
Why is DTI the key to your mortgage amount? Because the more you spend on debt, the less money you have left to pay off your mortgage.
Some types of loans allow higher DTIs than others. But, with most mortgages, lenders will want you to have a DTI of 43% or less.
For example, let’s say you have a gross monthly income of $ 5,000. You are already paying $ 1,000 per month on existing debt. How Much Mortgage Can You Afford?
- Max DTI: 43%
- 0.43 x $ 5,000 = $ 2,150
- Maximum debt payments: $ 2,150
- Existing debts: $ 1,000
- Maximum mortgage payment: $ 1,150
Now you know that you can only afford a house if the monthly payment is $ 1,150 or less.
Remember to include property taxes, home insurance, and private mortgage insurance (PMI) when estimating your mortgage payment.
Depending on your lender, a DTI greater than 43% may be allowed.
On some compliant loans, Fannie Mae and Freddie Mac have set their maximum DTI between 45% and 50%. And it is possible to get an FHA loan or a VA loan with up to 50% DTI.
However, you’ll likely need “ compensating factors ” to make up for the high DTI – like a big down payment or a great credit score.
Find out how much house you can afford (April 26, 2021)
How much should my mortgage be in the real world?
All of these calculations may seem a bit theoretical. And your goal when deciding your mortgage amount should be more practical. You want a loan that will perfectly match your lifestyle, your needs and your ambitions.
The fact that a lender gives you $X amount – because of your DTI, credit score, down payment, and personal finances – doesn’t necessarily mean you need to borrow $X amount.
Yes, most of us borrow up to the maximum allowed. But that doesn’t mean you should.
What are your spending priorities?
It all depends on your lifestyle and your priorities. Suppose you enjoy traveling abroad, fine dining, sailing, or shopping. Borrowing the maximum amount may mean that you are sacrificing other luxuries for years to come.
It might be better to move to a smaller house and a smaller mortgage if it helps you maintain your current lifestyle.
How secure is your income?
You should also keep the security of your income in mind.
You probably won’t want the biggest mortgage possible if you have a job where layoffs are common – or if you plan to change jobs soon and aren’t sure you will earn the same amount.
Lenders also have these questions in mind. That’s why they usually want to see two-year employment history on your mortgage application. They also want to know that any income you use to qualify for the loan will continue for at least three years.
Mortgage payment examples
Here are a few examples to show you how factors like DTI and credit can affect your home buying budget.
Million dollar house
Mortgage reports have looked into the issue, How much income do you need for a million dollar house? And the response revealed a surprisingly wide range of earnings.
We found that a “primary” borrower (with a small DTI, an exceptional credit score, and a 20% down payment) might be able to buy a $ 1 million home with household income as well. down that $ 100,000.
But someone with a lot of existing debt, moderate credit, and the smallest possible down payment might need an annual income of $ 225,000 to afford the same home.
How to come? Well, as we’ve just established, your income is only part of what determines your maximum mortgage capacity.
Your debt plays an important role, as does your credit score and the amount of your down payment.
$ 100,000 salary
Likewise, we have answered the question How much house can I afford if I earn $ 100,000 a year?
Again, responses varied widely based on these same factors: DTI, credit score, and down payment.
Borrower 1, with a credit score of 760, no existing debt, and a 20% down payment could be approved for a loan of approximately $ 721,000.
But borrower 2, with a credit score of 650, $ 250 in monthly debt payments and a 15% down payment could be offered only $ 561,000.
That’s a difference of $ 160,000 in homes that these two borrowers can easily afford – even if they earn the same amount.
Also, remember that to get the best deal and the lowest mortgage rates, you need to be in a very good financial position. Everyone pays a little – or a lot – more.
Find out how much home you can afford (April 26, 2021)
How to afford a bigger mortgage
You can afford a more expensive home by following three simple steps when preparing to apply for a mortgage:
- Pay off certain debts, especially credit card balances. Not Only Are You Lowering Your DTI, But Reducing Card Debt Should Increase Your Credit Score
- Save a bigger down payment. The more skin you have in this game, the more lenders like you. A larger down payment often earns you a lower interest rate and / or a better home
- Work on your credit score. As long as you pay your bills quickly, credit card balances are often the biggest drag on your score. Each must be less than 30% of the card’s credit limit. Additionally, in the months leading up to a mortgage application, you should avoid opening and closing credit accounts.
Of course, these steps can be easier said than done, especially for a first-time home buyer.
How are you supposed to pay off your debts and increase your savings at the same time? It is often difficult to meet even the monthly expenses.
But almost everyone – at least, almost anyone with home ownership plans – can find savings in their household budget. And it’s surprising how often a small improvement in your DTI, down payment, or credit score can make a big difference to your mortgage deal.
So do what you can. But if your financial situation isn’t perfect, don’t let that stop you. Mortgage programs today are flexible, and you might be surprised at what it takes to qualify.
Check your mortgage eligibility (April 26, 2021)
How to calculate your DTI
We’ve talked a lot about debt-to-income ratios in this article. Knowing yours is key to knowing how much home you can afford.
So, in case you were wondering, here’s how you can calculate your own DTI ratio for mortgage eligibility.
First, add up all the monthly expenses included in your DTI:
- Estimated monthly housing costs (you can use a mortgage calculator for this)
- Minimum payments by credit card
- Car payments
- Other monthly loan payments
- Obligations like alimony and child support
Then you need to know your gross monthly income.
Remember, this is the highest number on your pay stub, before tax deductions and so on. If your income varies significantly – perhaps seasonally – use an average over the past two years.
Now divide the first number (total monthly debt) by the second (income before tax).
Federal regulator on Consumer Financial Protection Bureau give an example:
“If you pay $ 1,500 a month for your mortgage and $ 100 a month for a car loan and $ 400 a month for the rest of your debt, your monthly debt payments are $ 2,000. ($ 1,500 + $ 100 + $ 400 = $ 2,000)
“If your gross monthly income is $ 6,000, your debt-to-income ratio is 33%. ($ 2,000 is 33% of $ 6,000.) “
If you are using a calculator, you will need to multiply the result by 100 to get a percentage. So your display shows 0.3333 but your DTI is 33.33% (33% when rounded up by your lender).
What are the current mortgage rates?
Current rates are still low, which is good news for home buyers. The lower your interest rate, the more real estate you get for your dollar.
Remember, there is no “perfect” amount to spend on your home loan. The decision is personal – it depends on how much you earn, how much you are currently spending each month, and how much of the housing payment you are comfortable with.
So explore your options, check your rates, and choose the mortgage amount that’s right for you.
Check your new rate (April 26, 2021)