Before you begin looking at homes, you’ll need to get some idea of what you can purchase. It can spare you a lot of aggravation by making sure you are searching in the proper price range.
There are 4 important elements that will weigh into how much house you can purchase:
- monthly gross income (before taxes)
- long-term debts
- money available for a down payment and closing costs
- your credit in general (late payments, collections, judgments) and of course the actual score is of huge importance
Income
Mortgage lenders by and large say that your housing expenses shouldn’t exceed thirty percent to thirty eight percent of the borrower’s gross monthly income. The housing expense should include mortgage principal, interest payments, property taxes and homeowners insurance policy. For Federal Housing Administration (FHA) mortgage loans, this figure needs to be 41% or below the homebuyer’s gross monthly income. If you have no idea of what your property taxes or homeowners insurance will be use 1% of the sales price (divided by 12) for the taxes and $50 a month for the homeowners insurance as a very rough estimate.
You are able to include many types of income besides your standard hourly or salary income:
- commissions or overtime may be used when documented for 2 or more years generally (shows on your W2 form)
- self employment net income (after taxes)
- social security, veterans and retirement benefits may all be used
- child support, alimony and income from public assistance programs
- permanent disability or workman’s compensation payments
- interest and/or dividend income;
- rental income after deducting expenses and mortgage payments;
- income from trusts, annuities, partnerships, professional corporations and even long term payments.
Debts
Mortgage lenders will also use your regular long term (anything not paid off after 10 months) monthly debts and obligations:
- other real estate loans
- installment loans (bank loans, boat loans, auto loans, school loans etc.)
- revolving accounts
- alimony and child support
Your housing expenses plus long-term debts should not be more than thirty percent to thirty eight percent of your gross (before taxes) monthly income. For Federal Housing Administration (FHA) mortgage loans, the number shouldn’t exceed forty one percent of the homebuyer’s gross monthly income. Mortgage lenders ordinarily specify long-term debt as monthly expenses which extend more than 10 months beyond the close of your estimated closing day.
It’s highly recommended borrowers pay-off as much long-term debt as possible before applying for a mortgage loan.
Getting an idea of how much you can afford will help you find the maximum loan amount you can borrow.
Some financial advisers do advise consumers that once they receive their maximum loan amount from the mortgage lender to reduce that amount by 20% and then go shopping for a house. So, if you’re approved for $200,000 then you should truly look for a house under $160,000. Borrowers are oftentimes approved for loans higher than what they can genuinely afford.
Having an idea of what loan payments you can afford helps you determine the correct mortgage for you.
Down Payment
Mortgage lenders require borrower’s to have adequate money available to make the down payment – up to 20% (or more) of the selling price for the property and to pay closing costs; usually between 3 and 6 percent. You may look at the following for a down payment: savings, mutual funds, stocks and bonds, retirement accounts (401K), etc. Most mortgage programs permit you to use a gift of money from parents or relatives and all that’s generally needed is a letter stating the money was in fact a gift.