Home Buying Guide: Working Out the Price Range You Can Truly Afford
- Home
- By Kirstie H. on
Anyone thinking about buying a home should be ready to move quickly. The real estate market is hot right now, and the supply of homes for sale is low. Knowing your price ceiling is one of the most important steps toward finding the right place.
So how do you figure out what is affordable? Several factors come into play. The sections below cover how to arrive at the best price range for your finances.
The Main Inputs for Your Home Budget
Four key factors shape how much you can spend on a house:
- Income: Your earnings set the baseline for what you can pay each month. This covers any money that arrives regularly, such as a salary, investment returns, or alimony.
- Available cash: This is the liquid money you can put toward a down payment and closing costs. It may come from savings, investments, and other sources.
- Debts and expenses: Existing obligations and monthly spending need to be counted. Credit cards, loans, car payments, groceries, utility bills, and insurance all belong on the list.
- Credit score: Your score and credit history strongly affect whether you can get approved for a mortgage.
Understanding the Debt-to-Income Ratio
The debt-to-income (DTI) ratio sets your total monthly debts against your gross monthly income. Those debts include mortgage payments, insurance, and property taxes.
A higher credit score may qualify you for a higher ratio. As a general rule, though, monthly expenses should stay at or below 28% of monthly income.
Here is an example. A prospective mortgage payment of $1500 a month (taxes and insurance included) against a pre-tax monthly income of $5000 produces a DTI ratio of 30%.
The same math works in reverse to find a housing budget. Multiply your monthly income by 0.28. With an income of $4000 a month, that points to a mortgage payment of roughly $1,120, which keeps the DTI ratio at 28%.
Affordability With an FHA Loan
An FHA loan is a government-backed mortgage guaranteed by the Federal Housing Agency. It suits buyers with lower credit scores or a small down payment, since the down payment can be as low as 3.5%.
There are added costs to keep in mind. FHA loans carry an upfront mortgage insurance payment of 1.75% of the loan amount, plus an annual mortgage insurance premium ranging from 0.45 percent to 1.05 percent. On a $250,000 home, the minimum down payment would be $8750, with an upfront mortgage insurance payment of $4221 on top of that.
Affordability With a VA Loan
Veterans may be eligible for a VA loan, which is a mortgage backed by the Department of Veterans Affairs. These loans offer several advantages:
- No down payment is required.
- There is no monthly mortgage insurance.
- Interest rates are lower than those on many other loan types.
Applicants first need a Certificate of Eligibility (COE). This document shows any mortgage lender you approach that you qualify to apply for a VA home loan. To receive a COE, you must meet one of these conditions:
- 181 days of active service during peacetime.
- 90 consecutive days of active service during wartime.
- More than six years of service in the National Guard or Reserves, or 90 days of service under Title 32, with at least 30 of those days consecutive.
Another point in favor of VA loans: unlike other federally backed mortgages, they place no cap on how much you can borrow.
Pin Down Your Borrowing Power With Pre-Approval
The most reliable way to learn what you can afford is to obtain a pre-approval letter from a lender. The process is easy and free. It establishes a preliminary mortgage amount for your purchase and comes with a rate quote for that amount. That information is essential for estimating loan costs and setting a budget. The letter can also help your realtor focus on homes that sit comfortably within your means.
Getting one is simple. Contact your lender and supply some basic details, such as your annual income and Social Security number. The lender runs some checks and tentatively decides how much it is willing to lend you. Keep in mind that a pre-approval letter does not guarantee a loan.
If buying a home is on your mind, begin your search online today and see how much house fits your budget.