How Much Mortgage Can I Afford?

Before you ask yourself," How much mortgage can I afford?" you should ask yourself,"How much mortgage do I want to afford?" The reason for this is that different price points will require different mortgage strategies, as do different financial situations. If all homes were valued the same then it wouldn't matter. However, this is not the case.

To start, lenders look at two numbers, both having to do with your debt to income ratio. Typically, a lender will allow 28% of your gross income for your housing expense. This includes principal, interest, taxes and insurance (otherwise known as PITI). The second number is housing plus recurring debt. This incorporates any debt that probably won't be paid in the next 6 months or so (credit cards, child support, etc.) Lenders usually allow 36% of your total gross income to go towards this. A good thing to keep in mind is that with government loans (mortgages insured by the FHA) these numbers change to 29% and 41% respectively.

To illustrate, a potential homebuyer makes $40,000 per year ($3,333 per month). This allows them to allocate $933.33 towards a monthly house payment and $1,200 towards a house payment and recurring debt. Assuming this buyer fits the housing plus recurring debt requirements they would be able to take out a traditional 30 year mortgage between $92,700 and $102,978.51 with an interest rate of 6.75% and taxes and homeowner's insurance at the national average. This doesn't allow much to buy a house with.

A second scenario takes the same borrower and applies an interest only mortgage. Typically, with interest only mortgages the borrower saves about .25% on the interest rate. This is because the loan never actually amortizes. The mortgage in this case would carry a rate of 6.75% and would allow the borrower to be able to afford a house that cost roughly $175,000 (the payment would be $947.92). Since the interest only term is usually only three years by this point, the borrower would hopefully be making more money or would have sold. This option is good for borrowers who plan to be making more money or don't plan on keeping their home long term.

A third scenario applies a mortgage buydown. With a mortgage buydown, the interest rate is "bought down," which in turn brings down the monthly payment for a specific period of time. In the case of a 3-2-1 buydown the rate is bought down and incremently increases each year until year 4, when it reaches the proper level and remains there for the remainder of the loan. The kicker here is that there needs to be a lump sum of cash to apply to the buydown. This can come from the seller as a perk to buying the house, the lender in exchange for a larger interest rate after the buydown period is over or the borrower. This situation is especially valuable to someone that has recently come into a lump sum of money (inheritance, one time gift, etc.) but doesn't have the required income to make the monthly payments. In this scenario the borrower can buydown the interest (and, in turn, the monthly payment) in order to afford a more valuable house.

As you can see, there are several ways to afford more mortgage. Aside from the methods mentioned, there are also many government insured programs (these will be discussed in future blogs) that allow borrowers to borrow more than the value of the house in order to make improvements. With a little research and some financial creativity, you'll be on your way to purchasing the right home in no time.

You may also want use Mortgage Calculators to analyze different borrowing scenarios in order to make a more informed decision.