How much house can I afford?
Purchasing a home is one of the biggest money moves you’ll make in your lifetime. And if you’re like most home buyers, you will need to finance at least some portion of your large purchase with a mortgage.
So what do mortgage lenders look at to determine how much house you can afford?
A lender will examine things like credit score, debt-to-income ratio, and down payment. And while your credit score is a major factor in getting you approved for a mortgage, your debt-to-income ratio is actually the indicator of how much house you can realistically afford.
What is a debt-to-income ratio (DTI)?
The debt-to-income ratio is a percentage of the borrower’s total monthly obligations including housing expenses and recurring debts compared to reliable monthly income. Your DTI tells lenders how much money you spend versus how much money you have coming into your household, and it’s used to determine your ability to repay the mortgage, as well as other outstanding debts.
How and when should I calculate DTI?
As soon as you decide you’re ready to start the home buying process, schedule some time to talk finances with a lender that specializes in mortgages. Your mortgage lender will help you calculate your DTI, so you are aware of what works best with your budget. You can also calculate your DTI yourself by adding up your monthly minimum debt payments and dividing it by your monthly pre-tax income.
What debts are included in DTI?
The only monthly payments you should include in your DTI calculation are those that are regular, required, and recurring (you can exclude living expenses like utilities, etc). Remember to include the actual monthly payment, rather than a full account balance or the amount you typically pay each month.
Examples of debts you should include when figuring your DTI include the following:
- Your rent or monthly mortgage payment
- Homeowners insurance premium
- Homeowners association (HOA) fees that are paid monthly
- Auto loan payments
- Student loan payments
- Child support or alimony payments
- Credit card payments
- Personal loan payments
What is considered a good debt-to-income ratio to get a mortgage?
When it comes to applying for a mortgage, the lower your DTI, the better. A DTI lower than 45% is considered ideal, but specific requirements can vary based on the type of mortgage you’re applying for.
Is my income calculated differently if I’m self-employed?
Self-employed people have the same access to the same mortgage options as do “traditional employees. However, the tricky part for self-employed borrowers can be providing the documentation for income that can actually get you qualified for a mortgage. For example, any undocumented payments for work done “off the books” does not count as qualifying income. Most tax write-offs reduce your qualifying income, as well. And if you’re self-employed and made substantially more this year than the year before, lenders unfortunately don’t give you credit for all of it — they’ll average it over the last 24 months.
Since large tax write-offs often lower your income in a lender’s eyes, DTI can be very important for self-employed borrowers. If your existing personal debts take up a large portion of your personal budget, you should really consider paying down debt before applying for a mortgage, especially if you are self-employed.
Self-employed borrowers may have to provide a bit more documentation to prove steady, reliable cash flow, but as long as you meet loan guidelines and can provide the necessary documentation, that should not stop you from buying a home or refinancing.
So, you’re ready to buy a house? We can help get your finances in order.
The mortgage experts with Silverton’s Wilpower Team are ready to make your home buying dreams come true. Our expert mortgage lenders will walk you through the process of getting your finances in order so you can apply for the mortgage that works best for you.
Contact us today to get started!