Determining how much mortgage you can afford depends on several factors, including your household income, monthly debts, savings available for a down payment, and the type of loan you are considering. Here are some steps you can take to estimate how much mortgage you can afford:
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Calculate your debt-to-income ratio (DTI): This is the main way lenders decide how much you can spend on a mortgage. The 28/36 rule is a good rule of thumb to follow, which states that you shouldnt spend more than 28% of your gross monthly income on housing expenses and no more than 36% on total debt, including your mortgage payment.
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Determine your down payment: Most home loans require a down payment of at least 3%, but a 20% down payment is ideal to lower your monthly payment, avoid private mortgage insurance, and increase your affordability.
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Consider the type of loan: With at least a 20% down payment, you might be best served with a conventional loan. However, if you are considering a smaller down payment, down to a minimum of 3.5%, you might apply for an FHA loan. Loans backed by the FHA can also have more relaxed qualifying standards — something to consider if you have a lower credit score.
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Use an affordability calculator: Many online calculators are available to help you estimate how much mortgage you can afford based on your income, debts, and other factors. These calculators can also help you determine your monthly payment, closing costs, APR, and mortgage interest rate.
Remember that interest rates only tell part of the story. The cost of a mortgage is reflected by the interest rate, discount points, fees, and origination charges. This cost is known as the annual percentage rate (APR), which is typically higher than the interest rate. The APR lets you compare mortgages of the same dollar amount by considering their annual cost.
In summary, to determine how much mortgage you can afford, you should calculate your debt-to-income ratio, determine your down payment, consider the type of loan, and use an affordability calculator.
