With the current condition of the real estate market, housing has become extremely affordable. Although obtaining a mortgage is tougher now, it should be no problem for those with good credit. By the way, if you do not know your current credit score, you can go to Profinity to get it. If you have the credit and wherewithal to buy a home, you can find a bunch of bargains.
So you as a buyer may be tempted to enter the real estate market. But the important question you must ask yourself is: how big of a mortgage can I afford?
There are many different home affordability calculators on the internet that can tell you by just simply plugging in numbers. Lenders also have their own formulas on how much of a mortgage they give you. Without having specific numbers, we can give you a rough outline to figure out how much of a mortgage you can afford.
There are two main factors that go into the formula of calculating the amount of house you can afford. First, lenders look at the gross monthly income of the household, which is the amount the potential homeowner(s) make on a monthly basis before tax and benefit withholding. Second, also compare that to the amount of monthly debt (dollars per month in payments) and the types of debt obligations in the household (car loans, student loans, etc.).
Lenders usually figure the amount of money they are willing to lend on a 28/36 rule, which refers to the debt-to-income ratio, or income ratio. This means that the monthly mortgage payment (including taxes and insurance) should not be more than 28 percent of the household’s gross monthly income, and the total monthly debt obligations (including your mortgage) should not be more than 36 percent of the household’s gross monthly income.
Once that is established, lenders can determine how much money to lend based on the monthly payment multiplied by the interest rate multiplied by the number of months in the mortgage term (15 years=180 months, 30 years=360 months).
To illustrate the point, let’s use an example of a household that makes $60,000 per year ($5,000 per month) and pays $400 per month in other debt (a car loan and a credit card) and there is $25,000 available for a down payment. By the lender’s 28/36 rule, the lender would take the monthly income and multiply it by .28 to get $1,400, which would be the maximum mortgage payment. Adding the existing debt payment of $400 to that amount would mean the maximum debt payment would be $1,800.
If we assume an interest rate of 4.25 percent for a mortgage, we calculate that this household would be able to afford a $180,000 house on a 15-year term and $245,000 for a 30-year term to meet the $1,400 monthly payment threshold, which includes property taxes and home insurance.
You can see here in this example, that a rough “rule of thumb” is that a household can afford about three times gross income for a 15-year loan and four times gross income on a 30-year term, assuming a down payment of at least 10 percent.
It is suggested (but certainly not required) that you go to a lender and get pre-approved for a mortgage so you’ll know how much house you can afford when you go shopping. Being armed with this information, owning a home should be a blessing and not a curse.
Happy house hunting!