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How Much House Can I Afford? Debt-to-income Calculation


If you have started thinking about purchasing a house or condo, before you begin looking at homes in person you should know just how much house you can afford. The last thing you want is to fall in love with a house only to find out that you can’t afford the mortgage payments.


How To Measure What House You Can Afford


Many sites out there will give you a cookie cutter calculation that is either too generous or too stingy. The best way to calculate the amount of a mortgage loan you can be approved for is to find several mortgage lenders and find out their maximum debt-to-income ratio in order to be approved. This varies from lender to lender and even from person to person at the same lender. This is because lenders will allow borrowers to have a higher debt-to-income ratio if other factors balance it out, such as a high down payment or an excellent credit score.


What Is Debt-to-income Ratio and How To Calculate It


Debt-to-income ratio, or DTI ratio, is the ratio of your total monthly debts to your monthly pre-tax income. Debts include car payments, mortgage payments, credit card payments, child support and payments for other loans, such as personal or education loans. Pre-tax income is not your take-home pay, it is your pay before taxes are deducted. For example if your gross salary is $60,000 a year and you take home $3,800 a month it is actually based on your yearly salary divided by 12 months, so $60,000/12 = $5,000. Note that this would be very different if you calculated it based on your actual take-home pay in your paychecks. Let’s say your monthly debts are $500. This would mean your DTI ratio is 500/5,000 = 0.10 and we multiply that by 100 to get 10% (before accounting for the mortgage payment). With the standard max DTI of 36% you could afford a monthly mortgage payment of about $1,300. Simply multiply .36 by your monthly salary and subtract all of your current debt to get the monthly mortgage payment you can afford.


Now keep in mind that the mortgage lender is going to calculate this based on if you owned the house, not your current situation, so this will include the mortgage payment, insurance, taxes and possibly homeowners association fees. It is calculated this way because lenders want to make sure you are likely to make your mortgage payments each month.


Why Should you Care About DTI?


This calculation is very important because if everything else checks out a mortgage lender could still stop you from getting a loan because you are a fraction of a percentage point over their maximum DTI ratio (first-hand experience with this one). In general, lenders do not want to give someone a mortgage with a DTI greater than 36%. This is because the higher your debt-to-income ratio is, the less likely you are to be able to pay off the mortgage. Let’s be honest, all mortgage lenders really care about is their ability to get paid for the duration of the mortgage. However, lenders have been known to accept applicants with a DTI ratio as high as 50% based on a high credit score and a high down payment. Use 36% as a benchmark to know you’re in the right ballpark and then find out the specific limit from a few lenders.


How Do you Find Out Mortgage Lenders’ Max DTI?


Two words: shop around! It is important that you do this regardless if you are looking for a mortgage lender, or any lender for that matter, to ensure that you are getting a good deal. Interest rates vary between lenders and that can mean a difference of tens of thousands of dollars for you in the long run. Contact at least 3 mortgage lenders and, although this may be difficult, ask them their maximum DTI ratio and interest rate before you give them ALL of your personal information. You are allowed to ask questions before you give sensitive information out, so ask away! After you find out the lenders’ max DTI ratio, also confirm how they are calculating it. This will give you a good idea of if you can afford a certain home. Remember, however, that this is based on your debts including the mortgage payment you are trying to get approved for, so you should get an estimate of the interest rate and monthly payment amount from each lender for the same mortgage amount, say $250,000.


Once you figure out that you fall below the lender’s max DTI for the mortgage amount that you specified, you can shop around and check out houses in your price range. Something to keep in mind is that if you put less than 20% down you will have to get private mortgage insurance. This will be an added cost that should be included in your lender’s calculation of your mortgage payment. Find out more about what private mortgage insurance is and how to avoid paying for it.


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