Making the decision to become a first time home buyer is complex, or if your looking to purchase your next house, sometimes it’s hard to know where to start. A good first step is answering the question: How much house can I afford?
While it might be tempting to simply use one of the many mortgage calculators you can find online, which will determine how much your monthly mortgage payment will be depending on the size of the loan, that alone doesn’t show the whole picture. You need to do more research, dig into your total financial situation and consider several types of loans that are available to you. The type of loan you get will determine your interest rate and required down payment.
Types of Home Mortgage Loans
Conventional Loans: This is the most common mortgage loan, and usually requires 10 percent down and good credit. Interest rates tend to be lower the better your credit. If you can put 20 percent down, you won’t be private mortgage insurance (PMI).
Fact Check: Many people believe you need a 20% downpayment to qualify for a conventional loan. That’s not the case. It’s great if you can, but it’s not a requirement.
FHA Loan: Available to all types of home buyers, an FHA loan requires a smaller down payment, usually 3.5 percent, and doesn’t require stellar credits. Interest rates will be higher, but qualifying for the loan is easier.
VA Loan: Home purchase VA loans are for our military service men and women of the U.S. armed forces. VA-guaranteed loans are available for your occupancy or a spouse and/or dependent (for active duty service members). The good thing about VA loan is they offer competitive interest rates and often times without requiring a downpayment or private mortgage insurance (PMI).
USDA Loan: This type of loan is for people buying in rural areas, and it is also a zero-down payment loan.
Interest Rate: Fixed vs Adjustable
After choosing the type of loan, you will need to decide if you want a fixed or an adjustable rate on the loan. This will determine the interest you pay.
Fixed Rate Mortgage: A fixed rate means your interest rate is “fixed”, and will not change. You will always know the amount of your monthly mortgage payment. However, it’s good to know if you roll other fees into your fixed mortgage, like property taxes or homeowners’ association fees, your mortgage payments may fluctuate over time.
ARM (Adjustable-Rate-Mortgage): This loan’s rate moves up and down over time. After the initial term ends, your interest rate and your monthly mortgage payment, increase or decreases annually.
Other factors to consider asking yourself, “How much house can I afford?”
Income: You’ll need documentation of your salary and any other income you receive from employment, self-employment, bonuses, commissions, tips, alimony, child support, social security, pension, or disability income. When the time comes to speak with a lender, you’ll need to provide several years of tax returns as well.
Debt: This includes student loans, credit card balances, car loans, medical bills, debt consolidation, personal loans, child support, alimony, and other outstanding debt you are paying off.
Other Expenses: Food (groceries, eating out), child-related expenses (daycare, activities, gifts), healthcare (monthly premiums, prescriptions, doctor visits), car maintenance and gas, personal care (gym membership, haircuts, clothing), pet care (vet, grooming, food, toys), entertainment (dates, movies, vacation), donations and gifts.
The 28-36 Rule is a Good Thing to Know
Most banks and mortgage lenders want to know two things:
- Your willingness to pay a loan (typically determined by your credit score)
- Your ability to pay the loan back
One thing they rely on for general guidance is the 28-36 rule to determine what a potential homebuyer like you can afford, and what they are willing to lend you. Even if your credit is impeccable, you will still need to prove you make enough money to pay your monthly payments.
The 28-36 rule states the following:
Your Maximum Household Expenses (PITI) should not exceed 28 percent of gross monthly income:
PRINCIPAL: The part of a mortgage payment that pays down the amount borrowed
INTEREST: Percent rate charged by creditors for lending you the principal
TAXES: This is your property tax
INSURANCE: This is your homeowners insurance
Your Total Debt or Debt-to-come Ratio (DTI) should not exceed 36 percent of your gross monthly income. Your debt determines, in part, how much of a mortgage loan you can afford. Lender calculate your debt-to-income by dividing your monthly debt by your gross monthly income. Most banks and mortgage lenders want this ratio to be 36 percent or lower. That’s why it’s a good idea to pay down your debt before applying for a loan. This is a general guideline lenders consider. It’s not a requirement to receive a mortgage.
Loan Term Mortgage Options
The majority of home buyers opt for 30-year fixed home loans. Opting for a shorter term, like a 15-year fixed mortgage, will result in higher monthly mortgage payments but in the long run will cost you less to buy the home.
Best Answer to “How much house can I afford?”
Get Pre-Approved: Now that you know the basics, put yourself in a position to get the house you want. Get pre-approved for a loan with a qualified mortgage lender. It will give you a good idea how much you can borrow, and how much home you can afford.
Sign up and speak with our real estate and mortgage specialists in your area to learn more about how they can help you through the home buying and mortgage selection process to maximize your hero savings. Our heroes save, on average, more than $2,400 if they use our local specialists to purchase their home. There’s no obligation, and we guarantee the most hero savings among all national programs.
Want to do a deeper dive into this issue? Here are some additional resources for you to explore:
- Understanding Different Types of Mortgages
- 7 Tips for Getting Approved for a Home Mortgage Loan
- Everything You Need to Know About VA Home Loans
- The Home Buying Process Start to Finish
VA Loan Benefits