How much home can I afford?
How much can (and should) I actually borrow?
More than likely when you are a first time buyer you will need to borrow as much as possible just to get your foot in the real estate door. If it looks like owning a home will be too big of a burden for you, then why not wait a couple of years before buying? Regardless, in these days of more restrictive lending practices, your lender will decide for you whether you can really afford that home or not.
Your heart says one thing, your wallet says another!
On the opposite side of the coin, just because you can borrow all the money you have been pre-approved for does not necessarily mean that you should. Avoid over-extending yourself. For example, just because you can afford a four-bedroom house when a two bedroom is plenty, why bother? There is more to life than owing a home so leave some money to enjoy your life. Ideally, when you buy a home, you should have six months of money in reserves to be prepared for the unexpected such as the furnace imploding or a between jobs situation.
Crunch YOUR numbers!
While obviously looking at homes on-line, running in and out of weekend open houses and day dreaming about your perfect home are all admirable pursuits, a cold light of day financial reality check is critical BEFORE you start looking for a home.
Step 1. Sit down and make a list of ALL your monthly expenses except rent. Include your groceries, gym membership, how much you spend on Starbucks each month, your utility bills, your medical prescriptions and co-payments, bus fares, internet and TV, how much do you spend on dining and entertainment, on-line purchases, car insurance, gasoline, vacation….AND I MEAN EVERYTHING! You need to be as honest with yourself as possible. Better to err on the high side rather than underestimating. Yes, this is boring as hell, but you’ll thank me later.
Step 2. Now subtract that number from your monthly take home (after tax) income. What are you left with?
Well, that is how much, based on your current lifestyle and monthly take home pay you have left to use towards a “mortgage”.
Be careful: remember that in addition to you monthly mortgage payment which covers principal and interest (PI), you will also have to pay the following each month:
- Property tax (for example, around $330 / month for a 3 bed house in Ballard or $125 / month for a 2 bed condo)
- Property insurance (around $60 / month for a house)
- Home owner association (HOA) dues that all condo and many townhome owners pay each month. This can be anywhere between $100 and $400 / month for lower to mid range condos and up to $1000 / month for high end condos.
Warning: the vast majority of on-line mortgage payment calculators do not take HOA dues into consideration and can be a big surprise for many first time condo buyers.
You will probably come across the abbreviation PITI which stands for Principal, Interest, Tax and Insurance.
Your lender will decide for you.
When you apply for a mortgage, the lender will base how much you can borrow on your debt-to-income ratio. The lender uses this ratio to determine how much mortgage debt you can handle and thus the maximum loan you will be offered. Your debt-to-income ratio is based on how much personal debt you are carrying as a percentage of your gross (before tax) monthly income.
When a lender makes a decision about your mortgage application, they consider both your ability and your willingness to repay the loan. The lender will gauge your willingness to pay the loan based on your credit report and previous commitment to paying rent, utility bills and previous loans. Lenders prefer for you to have been employed at the same place for at least two years, or at least be in the same line of work for a few years
After your debt-to-income ratio, the next major factor in determining how much you can borrow is how good is your credit rating?. In order to be approved for the prime (best) interest rates and hence lowest monthly mortgage payments, you need to have a high credit score . Interest rates can have a big impact on how much financing you can afford to borrow. A 1% higher interest rate means reducing your buying power by 10%!
