What Can You Afford?

Before starting your search for a home you must think about a couple of things:

• How comfortable are you with being in debt? After all, a mortgage is a very large sum of money to borrow and some people are uncomfortable owing this much to a lender. If you are uncomfortable owing money you might want to limit you house search to less expensive properties.
• How much of a mortgage will lender give you? Assuming that you are comfortable borrowing money for a house, you have to determine how much of a mortgage you can acquire in order to limit your home search to properties you can afford.

Most mortgage lenders like to see a ratio of around 35 percent debt-to-income ratio as a guideline for how high your debt load should be. Another guideline to use is that no more than 28 percent of your gross monthly income should be used for housing expenses. When the lenders see these guidelines exceeded they start to consider the mortgage as risky, and they may either deny the loan or charge you a higher interest rate.

For example; let’s use the 35 percent ratio from above to estimate a mortgage for a family making $60,000 (gross) per year.

$60,000 per year works out to $5,000 per month, and 35% of $5,000 is $1,750. This is the total amount that the mortgage company feels that you should pay monthly to service debt.

You then subtract all monthly debt payments from the $1,750 (car payments, loans, minimum credit card payments etc.) to come up with the allowed monthly mortgage payment. Let’s say the family in question pays $200 per month to meet their debt obligations, then the balance ($1,750 - $200) $1,500 is the monthly mortgage payment allowed. This would equate to a mortgage of around $220,000 depending on interest rates and the length of the mortgage.

• The amount you borrow will depend on:
• The prevailing interest rate when you apply for the mortgage.
• The length of time you take out the mortgage for.
• The property taxes you will have to pay.
• The cost of mortgage insurance.

The size of the mortgage you can manage will depend on the interest rate in effect when you apply and the length of time you take out the mortgage for. The above calculation used a 6.5% interest rate and a 25 year term. If interest rates changed to say 6% then the mortgage amount could increase to $230,000. If the interest rate remained the same and you choose a 30 year term then the mortgage amount would be $235,000.

One other thing to keep in mind is that the mortgage payment often has two other parts to it, property taxes and mortgage insurance. This would affect the size of the mortgage by reducing the amount available for the actual mortgage, if taxes and insurance payments were to total $200 per month then only $1,300 per month is going towards the mortgage and a $190,000 house would be what you would be looking at.

A pre-approved mortgage is an amount of money a lending institution is willing to loan you given your credit history and the approximate location of the property you are looking at. You should consider applying for a pre-approved mortgage before you start looking for a home. With the knowledge of how much mortgage money is guaranteed you are better able to narrow your home search to homes in your price range, and when you find one you are in a better bargaining position knowing there is no problem with financing.