Most people will leave the job of determining how much house they can afford to a professional. This task is usually performed by a banker, mortgage lender or real estate agent. But there are ways to determine how much house you can afford on your own and well in advance of meeting with anyone who’s familiar with the process.
How much mortgage can you qualify for?
Since most of the purchase price of a new home is financed through the mortgage, the answer to this question comes very close to answering the broader question, how much house can I afford? In most home purchases the mortgage represents 80% or more of the purchase price, so basically it’s a matter of finding out how large a mortgage you can qualify for, then adding your down payment to it.
Mortgage lenders use the 28/36 rule—no more than 28% of your stable monthly income should go toward the house payment (principal, interest, property taxes, insurance and home owners association dues, if any), and not more than 36% for all debts combined. That means car loans, credit card payments, student loans, plus the new house payment.
A few years ago, back in the days of no income verification loans, this was generally not a factor. Today, when lenders are actually verifying employment and income, it’s crucial.
Lenders are generally looking at a minimum two year employment history, but they’re also looking at income stability. What that means is that if you’ve only received bonus income in one of the past two years, they may not include it in your income. If overtime income is only recent, or if it’s been sporadic, it will also be excluded. Self employment and commission income will be averaged over a two year period and sometimes longer.
Moral of the story: our idea of how much money we make may not match what the lenders think we make!
Not so long ago you could get some type of mortgage to fit what ever credit score you had. No more. Lenders are looking at your credit to be at least “good”—credit scores well into the 600s with no major derogatory information.
Bankruptcies, foreclosures and even recent late mortgage payments can be disqualifiers. Pull your credit well in advance of applying for a mortgage that way you’ll have time to fix any errors on your credit before involving a mortgage lender.
If your credit and income stability are good, then you’ll be able to afford a home worth the amount of the mortgage you qualify for, plus your down payment.
The forgotten part of buying a house: paying off your mortgage
When most people close on their homes, they’re mostly just happy to close and move into the house. But the Part B of the purchase is paying off the mortgage, and there are more reasons to do that now than ever before.
Real estate appreciation is no longer a certainty, and this can be especially true if the market you’re buying in has had a big run up in prices in recent years. Higher prices mean higher risk, and one of the best ways to offset this is by paying down and paying off your mortgage early. Advance payments on your loan can help preserve your equity even of the price of the home falls.
You can keep track of how much you owe on your mortgage with a mortgage amortization schedule.
You can generally get a mortgage amortization schedule from your lender when you close on your new home. This will show you how much you owe on your mortgage after each payment that you make. If you have an amortization schedule, or if you want to see how much quicker you’ll payoff your loan by making extra payments, use a mortgage amortization calculator to get that information.
Kevin Mercadante is a professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.