You can’t start shopping for the perfect home without gauging your purchasing power. You know how much cash you have, so the question is: How much more can you borrow?
This guide will help you answer that question, but there’s one more you should ask yourself. How much mortgage can you actually afford? When you sign that loan agreement, you want to be sure you’re not biting off more than you can chew.
By using our mortgage calculator, and taking a few key measurements in your life, you’ll soon have a solid price range you can take with you on your hunt.
How much can I borrow for a mortgage based on my income?
We suggest running a few different scenarios through the calculator. If your household ever loses a source of income, or unexpected expenses come up, you’ll be able to see how much that alters what you can afford.
How much can I get for a home loan?
The reason it’s so important to focus on your budget, rather than your borrowing power, is that lenders tend to approve borrowers for mortgage loans at the very top of their affordability range.
That might seem counterintuitive. You’d think the lender would worry that a single change in your life — like a long-term illness or an unexpected child — would suddenly put your payments at risk. (Plan to have an emergency fund at the ready should anything major pop up.)
It’s true that lending you a huge sum will make it more likely you’ll default on the loan. However, the bigger the loan, the greater the amount of interest you’ll pay over its lifespan. More interest is more money for the lender.
So lenders are motivated to balance risk and reward, allowing you to borrow a sum that will strain but not break your budget.
Factors your lender will consider
When you’re being considered for a mortgage loan, your lender will look at your overall financial standing, not just your income. There are a few other factors that will influence how much you can actually afford to borrow.
Your credit score will have a big influence over whether you are approved for a loan and what kind of interest rates you’ll have access to.
A high credit score indicates that you’re used to borrowing money and you pay your bills on time. If you have a low score, lenders may charge you high interest for borrowing even small amounts to compensate for the perceived risk.
Unsure of how you rate? You can find your credit score through Credit Sesame for free.
This ratio examines how all your monthly debt payments compare to your gross monthly income. Think of your auto loan, student loan and credit cards.
Comparing these figures gives lenders an idea of how likely you are to keep up with all your debts, including a monthly mortgage payment.
When you input your debts into the calculator, make sure they’re accurate. Don’t underestimate or lowball your estimates, because lenders will see the full picture and base their numbers on that anyway.
Loan-to-value (LTV) ratio
This ratio compares the amount you hope to borrow with how much the property is worth. The more you put toward a down payment, the lower your LTV ratio will be.
If you’re buying a home that’s worth $200,000 and you put down $20,000, you will have a balance of $180,000 on your loan. Since you’ve already paid 10%, you’ll still owe 90% of the value of the house. Your LTV ratio would be 90%.
How much house can I afford?
If you go straight to the lender to see how much you can borrow, you might be shocked by the figure they approve. But don’t start shopping for bigger houses with luxury features just yet.
It’s far more important to find a home that allows you to maintain your current lifestyle than to lock yourself into a loan that forces you to give things up.
Calculating mortgage affordability
So how do you figure out exactly how much you should take on with a home loan?
Using our handy mortgage calculator is a great start, but don’t forget that when you buy, your mortgage payment isn’t your only home-related expense.
You’ll face taxes, insurance, utilities and general upkeep. Then add in all the things that make a house a home, like furniture, paint, decor, cleaning and yard maintenance supplies.
When you’re thinking about how much you can afford, all of these expenses will have to factor into your monthly home budget.
How to qualify for more
Sometimes you’ll find you can actually afford more than you’re being offered.
If you’re not happy with how much you can borrow, you have some options to improve your eligibility for a bigger loan.
Cut down your debt
Do you think it’s your debt-to-income ratio holding you back?
If you can pay down your debt fast, you’ll improve your debt-to-income ratio and also give your credit score a considerable boost.
Talk to multiple lenders
You may find the mortgage amount you’re pre-approved for will vary greatly from lender to lender. Some will be more comfortable taking on risk or will see your finances in a different light.
Comparing a few offers from different lenders will also help you find a better interest rate, which will reduce how much you pay every month and over the life of your loan.
A Freddie Mac study found that comparing rates from at least five lenders can make a $3,000 difference in how much you save over time.
Make a bigger down payment
The more money you have to pay upfront, the lower your LTV ratio will be. That will make you more attractive to mortgage lenders.
It might not make them lend you more, exactly, but you won’t need as much from them and you might receive a better interest rate.
Plus, when you offer a larger down payment, you may also save yourself from paying extra for private mortgage insurance.
Your ultimate goal should be to ensure you strike a perfect balance with your mortgage: Borrow enough to buy a home that you’ll enjoy living in and not too much that you strain your budget and fall behind on your payments.
If you plan ahead and are prepared to compromise here and there, buying a home with a mortgage you can afford may be within reach sooner than you’d thought.
Source: Moneywise / Featured image by xb100 – freepik.com