What's the limit when shopping for a home?
How much "house" can you buy?
All too often, buyer start home shopping based on their needs: how many bedrooms, pool, location near school or work, etc. However, price tends to be secondary.
Today, homes are increasing in price as an exponential rate. It is wise to ask yourself, “How much can I afford?” Even if it’s not your first time around the block, you still need to know how much you can afford if you are refinancing or buying new property. The short answer: It depends. Let’s look at the different ways to calculate home affordability.
The secret behind determining affordability.
There are several factors in determining affordability. These factors include:
- Length of time on the job
- Credit history and score
- Current and outstanding debts
- Location (upper limits for government-backed loans)
Old Town Lending is known for being one of the most helpful resources for all buyers, regardless if this is your first home purchase or fifth. We can help you understand home affordability and how to possibly leverage yourself to maximize your borrowing potential.
Your debt-to-income ratio tells lenders how much of your income goes toward paying debts. Lenders want to know that you'll be able to make your mortgage payments on time, and research finds that people with high DTIs are more likely to have trouble making those payments.
Banks will typically utilize your annual income and debts to calculate the highest mortgage you can afford without increasing your debt-to-income ratio (DTI) beyond the limit.
The maximum DTI for conventional loans is 43%. Some government-backed loans like FHA and VA loans have maximum DTI of 43% and 41%, respectively.
Also known as a housing ratio, your front-end ratio includes housing expenses such as monthly mortgage payments, property taxes, monthly homeowner’s association dues, and homeowner’s insurance.
Your back-end ratio includes your front-end DTI plus all your other monthly DTI debt (credit card bills, car loan, etc.)
While both are important, most lenders focus on your back-end DTI because it presents the most accurate account of your recurring monthly costs.
Remember, it's important to be as accurate as possible when reporting your income to lenders. And don’t forget to include any income from bonuses or overtime pay. Most lenders verify income during the loan application process, so if your numbers are different from theirs, it can delay the process or cause your loan application to be declined.
Since lenders use your DTI to determine whether or not you’re capable of taking on more debt, it’s a good idea to know your DTI before you apply. Thankfully, the formula is pretty straightforward:
Step 1: Add up your total monthly debt payments.
Add up all recurring monthly payments that factor into your DTI.
Step 2: Divide that number by your gross monthly income.
Once you’ve totaled all your monthly debts, divide that number by your gross monthly income.
Step 3: Convert the total into a percentage.
Take the number you’ve just calculated and multiply it by 100 to get your final DTI ratio.
Debt to income ratio example:
If your total monthly payments are $1,000 and your gross monthly income is $5,000, your debt-to-income ratio is 20%.
Debt-to-Income Calculator IMPUTS
Debt-to-Income Calculator OUTPUTS
Lender Standards for Debt-to-Income Ratios (DTI)
Lenders want to know how well you're making ends meet and how much home you can actually afford. The lower your DTI, the less debt you owe and the more able you are to make monthly loan payments.
Lenders consider both your front-end ratio, which is the percentage of mortgage you pay relative to your income, and your back-end ratio, which measures your total debts, including mortgage expenses, against your income. It can be helpful to know how your spending and savings can impact your future homeowning goals, too.