Purchasing a home is usually the largest single personal investment people make, so it’s essential to calculate your mortgage affordability and loan eligibility before starting house hunting. While this process can be time-consuming, it also serves as an invaluable step in making an informed decision about your future residence.
First, determine how much you can afford by looking at your income and debts. These two elements are used by lenders to assess your financial situation and capacity to make mortgage payments.
The debt-to-income ratio (DTI) measures your total monthly debt payments, such as mortgages, car loans, student loans and credit card bills, in relation to pre-tax monthly income. It’s best to keep this ratio as low as possible during the application process and no higher than 43% once you become a homeowner.
Once you’ve identified your debt-to-income ratio, it is time to create a budget. You can do this either by using an Excel spreadsheet or one of several online budgeting applications and tools.
Building an emergency fund is also wise to guarantee you have enough funds on hand for any unexpected bills or payments. Most loan programs require at least 3 – 6 months’ worth of savings set aside in case an unforeseen crisis arises.
Your credit score can also influence loan eligibility. A high credit score may allow for better interest rates and reduced monthly payments.
A mortgage calculator can provide an estimate of your monthly mortgage payment and housing expense based on factors like budget, debt-to-income ratio, credit score and down payment amount. Furthermore, it gives you a ballpark figure for long-term interest costs should you decide to refinance.
The housing expense ratio, or front end, is calculated by dividing your monthly mortgage payment – which includes principal, interest, property taxes and homeowners insurance (PITI) – by your gross income. Most lenders require that PITI not exceed 28% of your monthly income as this percentage is the standard for most loan types.
Before performing this affordability calculation, you’ll need to factor in other expenses like utilities, food, clothing and transportation. These can vary by region, so it may be beneficial to research local housing costs first.
Furthermore, it’s wise to evaluate your savings and assets. Doing so allows you to determine how many months of mortgage payments could be maintained if you lost your job, had an accident, or became seriously ill.
When searching for a mortgage, it’s wise to get pre-approved before beginning your search. Doing this gives you an estimate of how much you can afford and which mortgage loan program best meets your financial objectives.
The most common type of mortgage is a conventional loan, which is issued by private banks or other lending institutions. However, you may qualify for an FHA or VA loan as these mortgages are insured by the federal government and offer certain advantages that make purchasing more affordable.