We’ve all seen those DIY shows where the host shows the buyers a stunning home with everything on their wish list, only to find that the cost far exceeds their budget. You can see how their hopes are crushed. The lesson: Before you begin searching for a home, know what you can afford and be realistic about what that budget will buy.
There are many apps you can use to calculate your budget –money.cnn.com, bankrate.com, zillow.com - but your best bet is to find a reputable mortgage professional to prequalify you. Here’s what those apps and professionals will factor into their calculations.
Gross Income: The income you make before taxes. This can include salary or self-employment earnings, bonus, child support, alimony, Social Security income, etc.
Front-End Ratio: The percentage of your yearly gross income set aside each month against your mortgage; this is likely to include principal, interest, taxes and insurance (including mortgage insurance as applicable).
Back-End Ratio: This is more commonly known as your debt-to-income (DTI) ratio. Debt includes credit card debt, loans, child support and alimony one pays, etc. Most lenders recommend that your DTI not exceed 36% of your gross income.
Credit Rating: Lenders have established a formula for calculating risk in lending called a credit score. A low credit score can mean the difference between getting a mortgage and not, or getting a mortgage at a much higher interest rate.
Down Payment: A down payment of 20% of the purchase price of the home is required by most lenders, although there are loan products that require less. Of course, the larger the down payment, the more favorably you will be viewed by the lender.
Just because a lender tells you that you qualify for a certain amount does not mean you have to spend up to that limit. The formulas used to calculate your qualification factor in only the present. Taxes go up, job opportunities change, medical expenses arise, families expand – there are many ways your expenses and/or income can change and, unless your income changes proportionally, that can put stress on your lifestyle and your ability to pay your mortgage. Some experts feel that the better approach is to focus on your net income – the money you actually take home – and to attach no more than 25% of this to your mortgage.
Before you begin shopping for your new home, be sure to apply for prequalification, then give serious consideration to the level of debt you are comfortable taking on. You’ll want to be comfortable and happy in your new home; your mortgage should not keep you up at night for the next 30 years!