Buying a home is a dream that many people share. The first step in getting into the home of your dreams is figuring out how much home you can afford. There are several factors that go into this calculation, and knowing what lenders look for will give you a head start in the process. Know how much home you can afford before you start shopping for your new home.
Debt to Income Ratio (DTI)
This figure calculates the amount of debt you have in relation to your overall income. Lenders want to ensure that you will be able to meet your monthly mortgage obligations after you have paid for other expenses like car loans, credit card debt, and student loans. Lenders add up all of your monthly debts, including your anticipated mortgage and divide this by your monthly income.
Most lenders look for a debt to income ratio of no greater than 36%. In this case, the lower this number the better. If you earn $5,000 a month, for example, and your debts total $1,000, your debt to income ratio would be 20%. One of the best ways to improve your chances of qualifying for a mortgage is to get this number as low as possible. Many people aggressively pay down debt before applying for a mortgage.
The housing ratio is the amount of your income that will be dedicated strictly to home payments. If your lender rolls all of your home related expenses into one payment, you may be paying PITI(payments, interest, taxes and insurance) in one payment. This should not exceed 30% of your gross earnings. A homeowner who earns $100,000 a year would ideally pay no more than $30,000 a year on these costs.
Another important factor that determines how much home you can afford is your credit score. This three-digit number will largely determine what interest rate you are approved for. Higher interest rates mean higher monthly payments, so having a high credit score will help you get approved for a higher priced home.
Having a lower credit score might not necessarily bar you from getting a mortgage, but it will make it more difficult. Banks vary widely in their credit score requirements. Some offer the best rates only to borrowers with a score of 720 or higher and others offer low rates to people with scores in the 600-700 range.
The best way to factor this in is to check your credit scores from all three credit bureaus and clear up any outstanding debt.
The more money you offer as a down payment, the lower the cost of your monthly mortgage. The down payment factors into how much house you can afford because lenders are more likely to approve you for a higher cost loan if you have a higher down payment. Conventional lenders often require 20% of the purchase price as a down payment while some first time home buying programs and the FHA (Federal Housing Administration) will allow you to put down as little as 3.5%.
Buying a Home in Huntsville, AL
Determining how much home you can afford in Huntsville is a matter of being realistic with your financial picture and taking into account all of the elements that lenders will. By lowering your debt-to-income ratio, raising your credit score, and saving for a down payment, you will be turning the keys in the door of your new home in no time.