Can You Afford to Buy a New Home?
A Bird’s Eye View of Homebuying Expenses
If you are in the market for a new home, you are probably asking yourself “can I afford to take on a mortgage and other housing expenses?” There are a lot of expenses associated with purchasing a home. Unless you have saved the full cost of the home, you will have to finance the home, make a down payment and pay closing costs and other fees up front. Then, on an ongoing basis, you will be responsible for mortgage payments, mortgage and homeowners insurance, and taxes. If the house requires some work, you will have other costs to cover.
How Your Debt-to-Income Ratio Affects Your Mortgage Application
One simple step to take in determining whether you can afford a home right now is to get pre-qualified. In order to pre-qualify for a mortgage, your debt-to-income ratio should be around 40 percent or lower. Most programs will accommodate a debt-to-income ratio of 43 percent, but some will require a lower ratio, making 40 percent a safer bet.
Your debt-to-income ratio is the percentage of your monthly gross income (income before taxes and other deductions are subtracted) that must be used to pay off monthly debt. To determine your debt-to-income ratio, your mortgage lender will add up the estimated principle and interest of the home you hope to buy, plus the estimated property taxes and homeowners’ insurance and other monthly debt; they will then divide the sum of the numbers into your gross income.
For example: Let’s say you make $4,500 per month; your estimated future monthly home debt equals $1,200 and you make monthly payments of $250 on your auto loan and $350 on other debts. In this case, your total monthly debt equals $1,800. By dividing $1,800 by your $4,500 income, you come up with your debt to income ratio, which would be 40 percent. In this case, you would prequalify for the mortgage.
Dig Deep to Determine if You Can Really Afford Mortgage Payments
To determine how the new home payments will impact your finances, you can sit down with pen and paper (or keyboard and Excel worksheet) and determine how much you have left over after paying your living expenses, savings, etc. You can get a rough idea by subtracting the following monthly expenses from your take-home income:
- Current debt (credit card debt, student and car loans, etc.)
- Living expenses (utilities, groceries, transportation, childcare, etc.)
- Future savings (emergency savings of 3-6 months’ salary, retirement, college, vacation, etc.)
- Future home improvements and maintenance
- Future utilities
- Future plans (see below)
Once you have calculated the amount of money you can afford to spend each month, consider your future plans. Are you just building a family? Do you need to buy a car as well? Do you have deferred student loans? Are you in the market for any other large ticket item that will add to your current debt obligations? Deduct these amounts from your take-home income as well and then look at your final number.
The amount that remains after you have subtracted your debt, expenses, and estimated future debt from your monthly take-home pay should be a close approximation of what you have left over to spend your mortgage, taxes, and insurance.
Don’t Stop Now, Keep Asking Questions
Once you’ve determined what you can afford to pay on a mortgage each month, you can then begin determining how much you will need to save for a down payment and how much of a mortgage you can afford to take on. You can also begin asking your mortgage lender about mortgage interest rates and loan types. It is important to remember, throughout the process, that you will someday have to make the payments. Taking on a mortgage obligation that exceeds your monthly earnings will create stress for you in the future, so make sure that you can comfortably afford to make this important investment before you set your heart on a new home.
*Need help with the calculations? Try the Consumer Financial Protection Bureau’s “Monthly Payment Worksheet.”
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About Mortgage Originators
VSECU's mortgage origination team includes Shari DeLatte, Elizabeth LaPerle, Mark Wright, Tammy Farnham, and Michelle Duprey. The mortgage originators help members navigate the path toward owning a home, with clear advice about mortgage options and timely support from the moment the mortgage application has been completed through closing and beyond.