Can you afford your dream home? Calculate your mortgage payment

Some financial steps require a little advance planning. Among the greatest: becoming an owner. Buying a home is probably one of the most important purchases you will make in your life.

First step in the home buying process: know the price of the house you can afford.

How much does buying a house cost?

Home prices have risen 43% since the start of the pandemic. And in the second quarter of 2022, median home prices were $440,300, according to the Fed. Mortgage rates also hit a new record high of 6%. It’s the highest they’ve been since 2008.

Price growth is expected to slow over the next year, but these numbers can still seem daunting to potential buyers, especially when these numbers don’t take into account all of the up-front and hidden costs of buying a home.

3 Upfront Costs to Consider When Buying a Home

The listed price of a house does not tell the whole story. When preparing to buy a house, you will have to cover several costs before getting the keys. And while there are ways to save on these costs, you’ll need to take a close look at your budget early in your search to ensure you have what you need to process and complete your home purchase.

  1. Advance payment: It’s a percentage of the selling price of your home that you don’t finance. Most lenders require you to put down, but knowing exactly how much will depend on the type of mortgage you have. Some government-backed mortgages won’t require you to deposit any money. “Some lenders may require a 20% down payment, while others only require 3% of the purchase price of the home,” says Shelby McDaniels, director of the Corporate Home Lending channel at Chase Bank.
  1. Deposit money: This is an amount paid to the seller as a “good faith” down payment and is a buyer’s way of showing a seller that they are serious about buying the home. In many cases, earnest money deposits can then be used as credit for down payments and closing costs.
  1. Closing costs: Usually 2% to 5% of the listed house price, closing costs cover the processing of your mortgage. This helps cover the cost of lender fees, inspection fees, title insurance, and appraisals. “While there’s no way a buyer can completely avoid paying these fees, there are ways homeowners can save on them,” McDaniels says. “Some banks offer buyers assistance with their closing costs if they use the bank to finance their purchase.”

How much house can you afford?

Once you’ve calculated your upfront costs, knowing how that overall purchase price translates to your monthly mortgage payment will give you a better idea of ​​what you can comfortably manage. Here’s a closer look at some of the key factors lenders assess when determining how much home you can afford and how to work out the numbers yourself.

Get pre-approved: This will tell you how much you are eligible to borrow to buy your home. Lenders will ask you to provide proof of income, employment verification, proof of assets, your credit report and supporting ID to start the pre-approval process.

Once you know how much you are allowed to borrow, you should use that as a benchmark to help you figure out how much you can afford each month. “The best way to make sure you’re buying within your means is to be fully pre-approved before you start your home search,” says Kristen D. Conti, broker and owner at Peacock Premiere Properties. “Today a borrower can be fully underwritten to the point that it is almost as good as cash, making their offer much more competitive.”

Calculate your debt to equity ratio (DTI): This number measures how much you pay each month for your debts compared to your disposable income. Add up all your monthly debt payments, such as your car payment, student loan payment, and credit card payments. Then, divide that total by your gross monthly income to get your DTI.

The lower your DTI, the better your chances of being approved for a loan. Most lenders prefer a DTI below 36% – anything higher could raise concerns about how well you’ll be able to handle new debt. It can also give you a better idea if it’s a good time to buy or if you should wait until you’ve paid down your debt balance before buying a home.

Calculate your front-end ratio: Your monthly housing costs divided by your monthly income is called your initial ratio. Lenders prefer that your monthly housing costs not exceed 28% of your monthly income. However, there are slightly higher thresholds for government guaranteed loans which require your monthly housing costs not to exceed 31% of your monthly income. “It’s important to write down every dollar you spend collectively for 90 days. This exercise can be very tedious, but it is also extremely useful in ensuring that you are fully prepared for home ownership,” says Conti.

Consider your annual income: This includes your salary and any additional income from side businesses or investments.

Check your credit score: Your credit score will play a role in determining your interest rate and loan terms. You can check yours by visiting a free credit scoring site like Credit Karma or Experian. Your credit card issuer may also offer free credit scores when you log into your account online or on your monthly statement.

An example: Housing affordability — in numbers

Here’s what calculating how much house you can afford might look like in practice:

Let’s say Joe wants to buy a house in Austin, Texas, where the median home price is $172,000. He proposes to save 20% of this median price for his down payment. Here is his financial profile:

• Credit score: 705 (range of 700 to 719 in our calculator)

• Annual income: $80,000

• Zip code: 73301

• Average monthly debt payments (utilities, credit cards, etc.): $500

Based on these numbers, Joe could afford to buy a $279,000 home with a 12% down payment, or about $34,000. However, most lenders prefer a down payment equal to 20% of the purchase price of the home, and in some cases some loans may require this.

Making a 12% down payment could mean higher monthly mortgage payments or it could potentially lower your chances of approval if the lender feels you’re not in the best financial position to make your payments. If you are approved, you may need to purchase private mortgage insurance to help your lender reduce the risk they take in lending you money if you put less money up front.

Given this, it would be safer for Joe to look for homes under $180,000 so he could afford to put down a bigger down payment up front. You can use the calculator below to see how much house you can afford.

Other costs to consider

Along with the upfront costs and the monthly payment you’ll be responsible for, home ownership comes with a variety of new expenses that you’ll need to budget for when calculating how much you can afford to pay on your mortgage each month.

A few costs you might want to consider budgeting for:

  • HOA fees: Depending on where your home is located, you may have to pay a monthly fee to your homeowners association for community maintenance.
  • Insurance costs: Home insurance is often required by lenders and is an ongoing cost if you hope to protect your home in an emergency.
  • Property taxes: Each homeowner is responsible for paying taxes on their property based on the value of their home and the tax rate of the county where the home is located.

“You should give yourself a large affordability cushion because there are many hidden costs and unforeseen repairs with owning a home,” says Ruth Shin, founder and CEO of PropertyNest. She suggests factoring in the costs of unexpected repairs, monthly utilities, improvements you plan to make, landscaping, and year-round maintenance.

The take-out sale

When it comes to home ownership, half the battle is getting your bank account ready to make the purchase. Once you’ve figured out how much you’ll need to cover your costs until closing day, knowing how much you can afford to pay for your monthly mortgage will ensure that becoming a homeowner doesn’t hurt your ability to achieve the rest of your life. your financial goals.

EDITORIAL DISCLOSURE: Any advice, opinions, or rankings contained in this article are solely those of Fortune Recommends editorial team. This content has not been reviewed or endorsed by any of our affiliate partners or other third parties.

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