Before you start shopping for a home, you have to know what price range is right for you. Calculating the maximum loan you can afford to support will show you what you can realistically look into and where changes can be made to help you qualify for a larger amount.
The Debt-to-Income Ratio
The benchmark for whether or not you can qualify for a mortgage loan is called the debt-to-income ratio (DTI). It’s a comparison of your total monthly debts to your gross monthly income and is expressed as a percentage showing exactly how much debt you’re carrying. Banks generally consider 43 percent to be the highest ratio at which they’ll consider extending a loan.
To calculate your DTI, add up all recurring monthly payments and divide that number by your gross income. Multiply the result by 100 to get the final percentage. Remember this calculation doesn’t include taxes, so it’s a good idea to repeat it using your net income to get a more realistic view of your spending capacity.
Maximum Payment Levels
In addition to DTI, a few other ratios factor in when determining how much of a payment you can handle:
- Total mortgage debt shouldn’t be more than 28 percent of your income.
- All payments related to housing, including taxes and insurance, should stay below 32 percent of income.
- The total amount of all debt is best kept under 40 percent.
Down payment also has an influence on overall mortgage costs. The bigger the initial payment, the less you’ll have left to pay off. If you can put down a large amount at the outset, you may be able to afford a home that costs a little more.
Trying to juggle all these numbers can be a challenge. Online mortgage calculators do the work for you by assessing your inputs and showing how much of a loan you can afford or what the monthly payments would be on a given home price.
To use a mortgage payment calculator, put in the price of the home you’re looking at or an average price for homes in your area. Select the terms and rates currently offered by your bank to see how the payment calculation stacks up against your budget.
Affordability calculators require your yearly income, total monthly expenses and your expected down payment. Some also include space to set aside money for savings. The final number you get is the maximum home price you can afford.
What Does the Bank Say?
Whatever your calculations turn out to be, your bank has the final word on whether or not to lend you money. A DTI of 36 percent or lower and a credit score of 740 or more puts you in the best position for securing a loan. These two metrics show how well you handle debt and how good you are about making monthly payments. If you have too much outstanding debt, chances are you won’t be able to get the money you need for a home. If this is the case, you can either look for a cheaper home or work on paying off current debts to reduce your DTI.
As tempting as it can be to shop for your dream home and worry about pricing later, you have to be realistic when you peruse the housing market. Assessing your current debt and understanding your limits in advance prevents disappointments and stops you from taking on more than you can afford. Once you know where you stand, you can find homes with prices that fit your budget.