How Lenders Determine How Much House You Can Afford
Before you begin searching for a home, it is imperative to not jump the gun; instead, you need to be realistic about your financial and life circumstances. You must know how much of a house you can afford, if you can afford one at all. Sometimes a buyer will find that after reviewing your current situation, they may need to stay a renter for a little longer until they can purchase a home without getting in over their head. Here are the top factors lenders typically consider when determining how much house you can afford:
One of the first factors a lender will analyze is your debt-to-income ratio, or DTI. Lenders use this measurement to ensure that you’ll have enough income to cover both your new mortgage payment as well as any outstanding loans you already have such as student loans, credit card debt, or auto loans. Lenders will expect your new monthly mortgage payment to not exceed 36% of your other outstanding debts. You can calculate this ratio yourself by taking your total monthly debt load and dividing it by your monthly gross income.
Your credit is the most important thing when looking to purchase a home. It will determine whether you are able to buy a home at all, how much of a loan you are able to get, as well as the interest rate. Credit scores are based on your previous payment history, overall level of debt, length of credit history, types of credit and applications for new credit. Read: How to get a Mortgage with Bad Credit.
Lenders will be apprehensive to lending to you if either your credit, or your age of credit is less than ideal. You can have a 780 credit score, but only one year of credit. Just because you have an excellent score doesn’t mean that you meet the lender’s standards in terms of a good credit mix. If this is the case, you may still be able to obtain a loan, but you will more than likely be paying a higher mortgage and interest rate, and also be required to submit a higher down payment.
Down payment requirements
There are great deals out there for first time home buyers. That being said, there is almost no way to get out of having straight cash for a down payment. A down payment is typically 20% of the home. You will always get a better interest rate for a loan on a home (and really any other loan for that matter) if you are able to pay a down payment of at least 20%. That amount does not include closing costs, which usually amount to about 2-5% of the total sale price of the home. See: How Much Money Can I Borrow for a Mortgage?
If your credit is poor or lacking, consider waiting to purchase a home until you improve your credit score, and/or are able to increase your income. Ideally, you should be debt-free when purchasing a home, and also have four to seven months of your expenses saved before making the leap. Of course, this is in addition to having money for a down payment and the costs of closing on the house. Below is an excellent video on how to get a mortgage loan with poor credit: