Getting a mortgage and buying a house is one of the most significant financial decisions. However, it may seem easy enough to go out and purchase the first big house that you come across when house hunting in Texas. But, if you don’t have all your finances in order, you could find yourself overwhelmed with debt or even losing the home you love. Many people don’t realize that a home is one of the biggest purchases you will make and should not be taken lightly.
Borrowers generally focus on the total mortgage amount; instead, one should concentrate on the monthly mortgage payment and whether it is something the borrower can afford. You can check https://altrua.ca for better understanding on this topic.
Ideally, your mortgage amount should not exceed 30% of your gross monthly income. Though the mortgage lenders can be a bit flexible, so if your DTI is on a little higher side, you need not worry (however, anything more than 40% is going to be a stretch unless you have a substantial down payment)
Want to know how to find the right loan amount with the right loan program?
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How Much Mortgage Should You Borrow?
Your mortgage amount should be something you can easily afford. If you borrow more than you can afford, it could be hard to keep up with your other bills. It will also be harder to pay off the house when the time comes.
So when you calculate, the first step is to figure out how much you can afford as a monthly payment. Make sure that your budget includes all your living expenses and your family members.
While calculating mortgage affordability, your DTI ratio will play a significant role, as this number compares your monthly income to your debts and expenses, including the new house payment. Remember that your lender will qualify your loan amount based on your gross income, not your net income. So if your gross DTI is 41%, you need to understand how much you can afford.
Other factors, too, like credit score, down payment, etc., matter when determining the loan amount. But the DTI ratio is one of the most significant factors that decide whether you can afford a specific loan amount.
There are different types of loans available on the market and many factors that affect your interest rate. Ideally, you should consult with a mortgage expert to determine how much you can afford, as this will vary from person to person. A mortgage lender might also require additional documentation for determining your income and expenses.
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How do Lenders Decide on How Much Mortgage you can Afford?
Mortgage lenders in Texas use three main calculation methods to determine how much money a borrower can responsibly borrow: front-end ratio, back-end ratio, and the Debt-to-income (DTI) ratio.
Front end ratio
The front-end ratio, also known as the housing expense ratio, is the amount of your monthly income that covers monthly housing expenses, including principal, interest, taxes, and insurance. This ratio is calculated by adding PITI (PITI stands for Principal, Interest, Taxes, Insurance) and dividing it by your gross income.
A general thumb rule for this front-end ratio is that it should not exceed 28% of your monthly income. However, many mortgage lenders are flexible on allowing up to a 32% ratio.
Back end ratio
The back-end ratio, also known as the total expense ratio, is the amount of monthly income that covers all your debts and housing expenses. It includes PITI mentioned above and other monthly debt obligations like credit cards, car payments, and student loans.
The general thumb rule for this is your total debt should not exceed 36% of your income. Like the front-end ratio, you might get away if up to 40%. However, lenders would love to see you below that.
Credit score
Your interest rates and your chance to qualify for a loan depend on your credit score. So if you have a good credit score, it will allow you to get lower interest rates and thus lower monthly payments. In addition, a better credit rating enables a lender to overlook some of the other factors while giving out the loan amount.
So before even applying for a mortgage, make sure you improve your credit score so that your DTI ratio is good and you also get the best interest rates.
Debt-to-income (DTI) Ratio
The DTI ratio is more complicated as it varies from lender to lender. Though typically, the higher your DTI ratio is, the greater the risk for the lender and thus the higher interest rate you will be charged on those loans.
So let us understand this with an example:
If you are planning to apply for a home loan and your gross income is $5,000 per month, and you already shell out $1000 for the existing debts from your income, your personal expenses $1000, so how much mortgage can you afford?
Your DTI ratio will be 42.1%:
($1000 personal expenses/$5000 monthly income) * 100 = 42.1%
So your lender would allow you a loan of up to $110000. However, it is not advisable to borrow more than you can afford, provided that you have good job stability and other assets in place to cover up emergencies and other unexpected expenses.
Local mortgage lenders usually don’t like it when your home loan payments go up considerably in comparison to your existing debts. The lowest DTI ratio is preferred by most lenders as it reflects that the borrower has better control over his/her financial affairs.
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How to Calculate DTI?
First, add up all your monthly payments that come due each month, such as:
- Estimated monthly housing expense
- Car payments,
- Credit cards,
- Student loans
- Other loan obligations or payments
Now divide the total with your gross income, which is the highest figure on your monthly pay stub. Now multiply the result with 100, and you get your percentage DTI.
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How will Debt to Income Ratio Affect your Mortgage Payment?
DTI is an essential factor in deciding how much mortgage you can afford because the more you spend on your debt obligations, the lesser the amount you can spend on your housing expense.
Ideally, mortgage lenders in Texas prefer that your DTI ratio be 43% or less. However, a borrower can potentially qualify for a mortgage with a DTI as high as 50%, but the rates increase rapidly as the percentage of debt obligations goes up. In some cases, you might even have to pay Private Mortgage Insurance (PMI) if your DTI Ratio is more than 48% or you have less than 20% down payment.
So make sure you talk to your loan officer and set what percentage of debt obligations you can afford before applying for a mortgage. This is important because the higher the DTI ratio, the higher the risk for lenders, and thus you will be charged with a higher interest rate.
However, if you get a PMI, it will be waived off once your equity in the house reaches 20%. But when this happens, you might have to pay an additional .5% to the lender for taking away this coverage.
Cost Beyond Monthly Loan payment
Now that you understand how much you can afford for your monthly mortgage payments, there are other costs associated with buying a home.
When determining the total cost of buying a home, you need to include the expenses involved with your monthly payment and interest and some other costs associated with purchasing a home.
Closing cost
This is one of those costs that can completely throw off a buyer’s calculations because it is directly related to the price of the home itself. In addition, it includes fees like transfer tax, lender fees, and commissions.
So before applying for a mortgage, make sure you know what your closing costs will be so that they do not come as a big surprise later on.
Property taxes
The government imposes property Taxes on the homeowners to pay for schools, law enforcement, fire protection, and other public services provided to that community.
So besides your mortgage payment, you need to factor in taxes for property tax.
Homeowners insurance
Homeowners’ insurance costs are something most home buyers forget when calculating the total cost of buying a home. Most lenders prefer that you have homeowners insurance before your mortgage is closed.
This ensures that they are protected against losses or damages when you own the property. It also protects them from any liabilities in the event of an accident on your property.
On average, homeowner insurance can cost anywhere from 0.5% to 1.15% of the value of your house every year, depending on where you live and the coverage purchased. So make sure you budget it.
Home maintenance
It is a cost that all homeowners have to face, no matter where they live or what type of house. On average, homeowners spend between $2,500 and $5,000 per year on home maintenance.
So when you are figuring out how much mortgage you can afford, remember to add these additional costs as well.
A Word of Caution
Do not stretch yourself too thin when buying a house that you cannot afford an expense that comes unexpectedly.
Remember that while buying a house is an important milestone, you need to make sure that you can afford it. Though there is no set formula for how much you can afford to spend on a house, there are guidelines and steps that you should consider to make sure you do not end up paying more than what you can afford.
Talking to your mortgage lender and understanding all aspects of your mortgage is crucial. So explore your options and see what fits best.
