How Much Can I Afford When Buying A New Home?

Buying a home is one of the most significant financial decisions you’ll make in your life, and it’s essential to make sure you can comfortably afford it. But how do you know what’s affordable? To answer this question, you first have to figure out what your budget is. 

You can do this by adding up all your monthly expenses, minus the money you plan to save. This way you’ll know what you have left to spend on your home. Next, take a look at the houses in your desired neighborhood to get an idea of the average price of homes. 

Below are some additional steps you need to take to find that magic number once you have established your bottom line—then partner with a real estate agent to see what the down payment will be and check with your lender to see how much you can borrow. 

Here is where you need to start… 

Debt-to-Income Ratio (DTI)

DTI ratio is one of the key factors banks use when calculating how much money can be borrowed. They will compare your monthly gross income to your total debts per month when deciding whether to approve your home loan. 

While some people with a good credit score succeed in qualifying despite high debt-to-income ratios, your chances are slim that you will get approved with high housing expenses. Make sure these do not exceed 30% of your gross monthly income. Most lenders don’t consider borrowers whose debt-to-income ratio is above 45%.

Homebuyers need to use the 28/36 percent rule when calculating how much property they can afford. This means they should spend less than 28 percent of their monthly income on house-related expenses and less than 36 percent on their total debts, such as loans, insurance, taxes, and mortgage payments.

Prime Example

Let’s say you spend $1,120 on insurance, car loan, student loans, and rent each month. This is your total monthly debt. If your pre-tax income per month is $4,000, then your DTI is 28 percent (1,120 / 4,000 = 0.28).

To figure out how much you need to spend on housing and expenses, reverse this process. The income should be multiplied by 0.28 to estimate the housing budget. In our example, the total payments shouldn’t exceed $1,120 if you want your DTI to be 28% ($4,000 X 0.28 = $1,120).

Tips for Improving DTI Ratio

If an enormous debt prevents you from qualifying for a mortgage on a house you want to purchase, you will need to decrease your DTI ratio. There are three main ways of improving the debt-to-income ratio:

1. Increasing your income
2. Consolidating debt
3. Paying off debt

Increasing your income and paying off debt may take a few years. If you are looking for a faster solution, try to consolidate your debt. While a balance transfer can help lower the DTI ratio and qualify for a mortgage, it doesn’t always work. 

Here are other things you can do if you’re looking to buy a house that surpasses what you’ll be able to afford:

• Spend less on clothes
• Reduce your entertainment expenses 
• Cut your household bills
• Cancel some vacation plans
• Sell your car or don’t buy a new one
• Make some extra money through side jobs

Other Factors to Consider When Calculating How Much Home You Can Afford

There are many costs to consider when purchasing a house. Closing costs, moving expenses, the down payment, the ongoing costs to maintain the home, property taxes, and homeowners insurance are just a few examples you need to consider when creating your budget. 

Aside from your total monthly debt, you will also need to consider your credit score, down payment for a house, and monthly income.

Credit Score

Before applying for a mortgage, you should try to improve your credit score. This will allow you to afford more even if your down payment remains the same. You will increase your chances of getting a lower interest rate with a stellar credit score and possibly borrowing a larger amount.

It is a good idea to review your credit report beforehand and resolve any issues. Check for negative factors and incorrect data. Inform the credit reporting agency immediately if you notice any mistakes in your credit report. 

You may need to provide some documentation to support your claim. This could include old financial records of payments made are a debt being resolved.   

Down Payment

Do you plan to apply for a home loan or mortgage? If so, calculate the amount you would pay for the ongoing costs of the home divided by the amount of your income after taxes to determine your ideal mortgage payment.

Lenders want to make sure the borrower has more equity in a house before giving them more money. If you want to get a better mortgage rate, your down payment should be big enough. 

If you have a lower down payment, the lender’s risk is higher, and so is the loan-to-value (LTV) ratio.

Debt

Many lenders calculate the total debt per month – which may include personal loans, car loans, credit cards, and so on – in the upcoming 12 months.

They may also consider debts paid for more than one year if these payments significantly influence the mortgage a borrower can afford.

Monthly Income

When thinking of how much home one can purchase, income is the first thing that comes to mind. It is one of the most obvious things that indicate someone’s purchasing power. 

The higher the income, the larger and more expensive the home one can afford. 

If you plan to buy a home, be sure to compare the total cost of homeownership to the amount you would pay for rent to determine if it’s financially feasible. Among other things, this cost includes mortgage, taxes, maintenance, and insurance.

An easy way to think about it is to only spend 28% (or less) of your gross monthly income on your mortgage and housing-related costs. If that sounds like a lot, remember that your home should be considered a long-term investment and part of your retirement plan.

Can You Afford a New Home?

It’s critical to review your financial situation before considering homeownership. Once you know where you stand financially, it will be easier to find the perfect home. Use our tips and suggestions above to figure out where you stand today. 

It’s also crucial to speak with a real estate agent to ensure that you can afford the home you’re looking to buy. Contact us today to help you find a house within your budget in the Sacramento real estate market.