Thinking about purchasing your first home? If so, then you may be wondering, “How much house can I afford?” Many first-time home buyers have this question, and figuring out how much you can afford in terms of a home mortgage is an important step in the process. In fact, determining the amount of lending you can qualify for is often the first official step, as most real estate agents and realtors will require you to bring in a mortgage pre-qualification letter before they’ll begin showing you properties.
While there’s no universal formula for figuring out how much of a mortgage you can afford, there are some considerations and factors worth keeping in mind that can help you get started.
Numerous factors will influence the mortgage amount you may be approved for. One of the main influencing factors will be your current annual income. Of course, current debts will also need to be considered. After all, you could be making a healthy salary of $100,000 annually — but if your annual debt repayments total $50,000 a year, this is obviously going to affect the amount that a mortgage company is willing to approve you for. Some examples of debts that will need to be considered when determining your mortgage qualification amount include:
- Credit card debt
- Car payments
- Student loan payments
- Additional recurring debts
Another important factor that mortgage lenders will take into consideration when determining your eligibility for a loan is your credit rating. Those with less-than-ideal credit may have a harder time getting approved for certain types of mortgages and may end up with higher interest rates. On the other hand, if you have a good credit score (approximately 700 or above), you should have no trouble getting approved for a competitive interest rate on your mortgage. You can view two of your credit scores for free, updated every 14 days, on Credit.com.
Don’t Become “House Poor”
When determining the answer to the question, “How much of a mortgage can I afford?”, it’s also important to understand the difference between your pre-qualification amount and the total amount you end up borrowing. For instance, when you receive a pre-approval letter for a mortgage, the amount for which you’re approved is considered your maximum borrowing amount based on the information you’ve given. This does not necessarily mean that you should borrow that total amount for your new home.
For example, you might be approved for a $250,000 mortgage. On the other hand, upon doing the math yourself and considering your monthly debts, utilities, home maintenance, insurance, and other costs, you may determine that you’d be much more financially comfortable buying a home that costs no more than $175,000. The last thing you want is to become “house poor,” where you’re left with little money after paying your mortgage/escrow every month.
Additional Tips and Considerations
Another important consideration to keep in mind when determining how much of a home you can afford is that of your down payment. This is the amount of money you’ll put down on the house out-of-pocket. The minimum down payment on most homes is through an FHA loan and equates to about 3.5% of the home’s total sale price. However, it is worth noting that with most mortgage companies, you’ll be required to pay Private Mortgage Insurance (PMI) on any home where you have less than 20% equity. Considering PMI can easily cost you more than $100 per month (or $1,200+ per year), you may want to put down a 20% or higher down payment on your new home in order to save money in the long term (if you can afford it, of course).
Unfortunately, many first-time buyers cannot afford to place a 20% down payment on a home. In such cases, the best thing you can do to save money on your mortgage is to secure the lowest possible interest rate you can find. This may mean shopping around and submitting applications to a number of lenders. Furthermore, paying ahead on your mortgage even slightly can drastically save you on interest down the road and help you get your home paid off sooner.
With so many considerations to keep in mind when determining what you can afford, the process can seem a bit overwhelming. To help, consider using this housing affordability tool. It can help you get a better idea of how much of a mortgage you can comfortably afford based on your current income, debts and other relevant factors.