Purchasing a home with a mortgage is typically the most significant personal investment people make. How much you can afford to borrow depends on multiple factors, not just the amount the lender is willing to loan you. You’ll need to evaluate your finances, priorities, and preferences.
The Mortgage Banking Association (MBA) recently reported that the average loan size for purchasing a home was nearly $369,000. With the current 30-year fixed mortgage rate at 2.96 per cent, the monthly payment would be $1,548 plus homeowners’ insurance and potentially private mortgage insurance (PMI). While that may seem straightforward, it’s also essential to consider the approximate cost of utility bills. For example, a home that has smart, eco-friendly appliances, solar power and other features that can reduce those bills is likely to be more affordable than a house with a slightly higher price tag that doesn’t. You can more effortlessly control how much you can afford by using a house payment calculator and then taking the other factors into account.
But that’s not all you have to think about to figure out how much home you can afford – you’ll need to consider the following as well.
Your Credit Score
Not only do mortgage lenders want to know that you earn enough money to make your monthly payments, but they also want to know how much of a risk they’re taking on by giving you a home loan. They use a particular formula to determine the risk level of prospective homebuyers that generally determine by their credit score. Those who have a low credit score will either be denied a loan or pay a higher interest rate.
As soon as you begin thinking about buying a home, you’ll want to check your credit scores and reports with all three of the major bureaus, Experian, Transunion, and Equifax. If there are any inaccuracies, it takes time to get them removed. If your score is low due to wasted payments, a high amount of debt, or other reasons, you’ll want to work on improving it first – aiming for at least 680, but the higher, the better.
While having a high amount of debt compared to your income is likely to result in a lower credit score, either way, lenders are going to calculate the amount you can borrow by using what’s called a DTI ratio. It compares your total monthly debt to your monthly income (pre-taxed). Generally, your housing expenses shouldn’t exceed 28 per cent of your monthly payment.
You know that you’ll need to have saved up a lot of cash for a down payment and closing costs, but did you know that most lenders want you to have even more money stowed away in your savings accounts before they’re willing to approve your loan? Even if your income and monthly debts stable, unexpected expense, layoffs, and so on can happen to anyone. Preferably, you should save at least three months of what you’d need to cover your costs during that period, including your home loan payments and all other monthly debts so that you can protect your mortgage should an unfortunate event occur.
There are personal circumstances you should consider too, for example, how stable is your job? If you were to lose it, could you quickly find another one that pays the same or better? What about expenses that you don’t have to pay now but may occur in the future, such as obtaining a new car or having kids who will go to college? You’ll want to have enough wiggle room to be able to afford them as well.
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