When deciding if you can afford to finance a home, it is important to know how much you can afford. Lenders do not want to approve you for a loan that could potentially overload you. This is the perfect time to review your personal financial situation; comparing your monthly debt to your monthly income. You need to have the ability to cover your current bills, as well as save for the future, and pay for any unforeseen emergencies.
To determine your debt-to-income ratio, you can do a few simple calculations. Information you will need:
- Monthly Income – This is any regular earned income that you can document. If you can’t document it or it doesn’t show on your tax return, then you can’t use it in your monthly income figure. There are some sources of unearned income that you can use, such as alimony or lottery pay-offs.
Something to keep in mind, gross income is what you receive before taxes are deducted and most lenders will use your gross income for their calculations. Net income is the amount after taxes, which is what you actually have the ability to spend on your expenses.
- Monthly Mortgage Debt – This should include your monthly mortgage principal payment, as well as interest, insurance, and taxes. If you are unsure of what your taxes and insurance will cost, you can estimate them at approximately 15% of your mortgage payment.
- Monthly Debt “load” – This includes all other monthly debt obligations like credit cards, installment loans, car loans, school loans, alimony, or child support. If it is revolving debt (such as a credit card), use the minimum monthly payment for your calculations.
(Mortgage Debt ÷ Monthly Income = ._ _ _ x 100 = _ _ %; should be less than 28%)
(Mortgage Debt + Other Monthly Debt ÷ Monthly Income = ._ _ _ x 100 = _ _ %; should be less than 36%)
Lenders may use slightly different formulas and consider other various factors when reviewing your personal financial situation. However, the general rule of thumb is that your housing expense should not exceed 28% of your gross monthly income and the combination of monthly mortgage expense and other monthly debts should not exceed 36%.
Depending on your individual situation, there may be some flexibility in these percentages. If you are able to make a larger cash down payment, the qualifying ratios will become less critical. Having a co-signer for your loan is another way to reduce the importance of the debt-to-income ratios.
Whatever financial route you choose to go, make sure it is something you will be comfortable with for many years. Don’t forget to factor in unusual expenses such as school tuition or vacation expenses; you don’t want to choose a higher loan amount simply because it is what you qualify for – You might qualify, but you could discover too late that it is more than you can realistically afford!
There are hundreds of loan programs available in today’s lending market. So take your time and shop around with the same care and consideration you use when shopping for your home!