When you're ready to invest in buying a home, one of the hardest parts is determining how much home you can reasonably afford. You'll need a target price range for your realtor in order for them to find you the right home. Before you get in over your head financially, there are a few things that you can do to narrow it down. Here are a couple of things that most mortgage lenders consider, which is advice many realtors share early in the home search process:
Mortgage Payment As A Percentage Of Your Monthly Income
One method used for determining how much house you can afford is to see how much of a loan you qualify for without exceeding a payment of one-quarter your monthly income, or the equivalent of a week's pay. Since the payment will vary based on your interest rate, the loan term, and any points on the loan, you'll want to work with a mortgage lender to pre-qualify before you set a budget. Your realtor may even be able to recommend a lender that they work with on a regular basis.
Home Price As A Multiple of Your Annual Salary
Another way to determine how much home you can afford is to calculate a sale price that is approximately two and a half times what you earn in a year. This is a bit more of a general assumption, though, because your monthly payments may still stress your budget if you get a high-interest rate or you opt for a short-term mortgage loan. So consider this method only if you're sure that you have wiggle room in your monthly budget for a higher payment if necessary.
The Debt-To-Income Ratio
Before you lock into a home price and have your realtor start pulling listings, remember that your debt-to-income ratio will also affect how much home you'll qualify for. If you're not familiar with what that is, it represents the total percentage of your gross income that is required to cover all of your financial commitments. This includes things like your housing costs, insurance, and any other loans or debts you carry.
The lower your debt-to-income ratio, the easier it is to meet your financial obligations every month. If you have a low ratio, your bank is more likely to allow you a loan that's at the higher end of your budget. If your ratio is high, your bank might be more hesitant about lending a large amount for your mortgage.
Be realistic about your finances when you talk to your realtor about the budget for your new home. He or she will help you determine the best price range to shop in and can even help you understand the market in your area so you're more likely to find a good investment.