Before buying a new home, it is important to consider the maximum amount you are able to afford. Although it can seem straightforward, in many cases the amount of house you can easily afford is not the same amount as the bank is willing to provide in a mortgage. Fortunately, calculating the amount is based on income levels, debts and the monthly payment that is easiest for your financial situation.
Debt to Income Ratios
The debt to income ratio is a key part of determining the maximum amount it is possible to take out in a mortgage. The words debt to income ratio refers to the percentage of minimum debt payments when compared to the amount of income that is earned each month.
Banks are allowed to provide loans, credit cards and other debts that have monthly minimum payments up to 36 percent of the total monthly income. Although the maximum debt to income ratio is 36 percent, many banks will limit the mortgage amount to slightly lower levels to reduce the risk of default.
Although the simple estimation of determining a monthly payment as 36 percent of total income minus any current debt payments will give a reasonable payment estimate for a mortgage, a realistic payment amount is often a slightly lower figure.
For example, if 36 percent of your monthly income was $2500 and you paid $500 a month in credit cards, car payments and other debts, then the monthly payment of $2000 for a mortgage should be an affordable amount. If you notice that other interests and expenses make it hard to pay more than $1500 a month, then it might be better to look for slightly less expensive houses to get an affordable price.
The payment amount on a home should calculate more than just the maximum amount. You should realistically look at spending to determine the actual figure that is affordable.
Reaching Realistic Estimations
The best way to calculate whether a home is affordable is reaching a realistic estimation of the maximum cost of a property. A realistic estimation includes taxes, insurance and spending habits to avoid feeling house poor due to taking out a mortgage that is hard to manage.
A conservative estimation of a monthly mortgage payment should strive to keep the expense down to 25 to 28 percent of the total amount. Conservative estimates leave extra room for potential repairs and additional costs that might arise at a later date.
An aggressive estimate for a home is around 33 percent of the total income level. Although it is possible to take out debts up to 36 percent, that figure includes all of your debts. Most banks will only offer up to 33 percent of household income for a mortgage.
Determining the amount of house you can afford is not always simple. In many cases, you will need to estimate your monthly payments based on the amount of income you make and the current spending.