How much house can you afford?
Every journey starts with a single step – your journey to homeownership starts with finding a single number.
When beginning the process of buying a house, it is important to have a price range within which to look for a home that meets your needs and will be affordable with your current income status. Fortunately, there are a few easy rules of thumb embedded in the mortgage approval process that make arriving at this number relatively painless — so easy that you can go into the mortgage application process with confidence, having worked the numbers out beforehand.
In assessing how much house you can afford, two factors must be considered: the overall cost of the house, and the cost of your monthly mortgage payments.
- Overall Cost: If you have good credit, a steady income, and a reasonable amount of preexisting debt, it is reasonably safe to estimate that you can afford (and will qualify for a mortgage on) a home that costs two-and-a-half to three times your annual household income. The figure that should be used for income is your gross annual income (GMI), or the amount of your paycheck before taxes, insurance and other expenses are taken out (as well as the same for your spouse or any other co-borrower). In addition, you will want to factor in steady income from other sources, such as retirement, disability, child support, social security or alimony. For all income, you must be able to show a history of at least two years and a likelihood that a given income source will continue. This worksheet will assist you in assessing your income and determining your housing ratio.
- Mortgage Payments: When looking at your monthly mortgage payments, a lender will examine two different ratios in approving your mortgage — the housing ratio and the debt-to-income ratio. The housing ratio is the maximum percentage of a borrower’s gross monthly income that can be used to make the monthly mortgage payment (including principal, interest, taxes, and insurance - PITI). This percentage will be pre-set based on the type of loan that you are applying for, and is typically 25, 28, 29 or 33 percent. The debt-to-income ratio, meanwhile, is the maximum percentage of a borrower’s gross monthly income that can be used for the house payment, plus all other debts. This is also predetermined based on loan type, and can range from 36 to 41 percent. Because your debt-to-income ratio is assessed, it is important to know how much outstanding debt you have going into the mortgage application process, whether it is from credit cards, automobiles or student loans. If the number is on the high side, you may need to pay off some of that preexisting debt before you begin your home buying journey.
And there you have it — if you can calculate your gross annual and monthly income, and multiply or divide by a set ratio, you can get a pretty good idea of how much house you can afford, and how much money a bank will be willing to lend you. Consider taking a home ownership education at Michigan State University Extension which offers community classes that are required for MSHDA down payment assistance programs as well as an on line course through MSU Extension and eHome America. In addition to relieving a lot of stress and guesswork when you start looking for a home, you’ll also be able to apply for a mortgage as fiscally responsible, informed, and confident consumer.
To contact an expert in your area, use the Find an Expert Tool, or call 888-MSUE4MI (888-678-3464).