Figuring Out Loans
5 Factors Determining Mortgage Affordability
“How much mortgage can I afford?” is one of the most common questions first-time home buyers ask. There are many factors that a lender will analyze before giving you an appropriate mortgage.
Your income amount is a crucial factor that determines your mortgage affordability. According to lenders, your cost of monthly mortgage should be no more than 28% of your gross earnings monthly. To work out your gross income, add tips or commissions, child support/alimony, bonuses, regular dividends, and annual interest earnings to your regular salary. To arrive at your monthly gross earnings, divide the annual amount by 12.
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Mortgage rates constantly fluctuate and even a slight rise in rates may affect your ability to buy. For example, if you buy a home worth 200,000 dollars with a fixed interest rate of 3.75% for 30 years, you will need to pay 926 dollars every month.
If your interest rose to 4.25%, your payment each month would increase by almost $60.
Credit scores are used by lenders to determine the risk level of borrowers, so this is the reason why people who have higher credit scores usually get reduced interest rates.
Having a less than perfect credit score does not necessarily mean you can’t own a house, but if your kind of loan partly determines your interest depending on your credit score, your purchasing power could be restricted.
To get a mortgage, you must have money available to use as a down payment. Down payment is simply a percentage of the whole price of the property that must be paid right away in cash, to bring down the mortgage amount. With regular mortgage financing, the down payment must be 20 percent or more, otherwise private mortgage insurance, aka PMI will have to be added to the monthly payment. Private mortgage insurance helps protect lenders from borrowers that could default on mortgages. Government-backed loans such as VA and FHA come with lower down payment requirements. No matter which kind of loan you opt for, you must make some upfront cash payment to complete the transaction.
While you don’t need to be free of debt to purchase a home, auto loans, credit card debit, student loans and so on can affect your buying ability.
Most lenders advise that your monthly mortgage payment, which includes principal, interest, insurance and taxes be under 28% of your gross income per month. This is called front-end ratio.
Also, your lender will review your back-end ratio, or debt-to-income ratio, which consists of your monthly financial obligations such as student loans, minimum credit card payments, child support/alimony and car loans as well as your principal, interest, insurance and taxes. Ideally, lenders advise that this shouldn’t be more than 36 percent of your gross earnings every month.