The best way to know how much you can afford to spend on a home is to get preapproved or prequalified for a loan, but the rule of thumb is that if you have money for a downpayment and can afford to rent, then you can most likely purchase a home.
Although the preapproval process is more complicated than the prequalified procedure, it will better explain how much you can afford to spend on a home, since the lender is actually committing to giving you a certain amount of money for a home loan.
The prequalification process is very simple and therefore a much quicker process when it comes to determining an estimate of how much you can afford on a home.
Essentially you share how much income you earn and how much debt you have with a lender, and they give you an estimate on how much you can afford to spend on a home.
With the prequalification process there are no fees to pay and you don’t actually apply for a mortgage, allowing you to compare lending rates and amounts with other lenders.
However, it’s just an estimate on your actual debt-to-income ratio and therefore the prequalification amount won’t be as accurate as a preapproval is.
The preapproval process is more complicated, requiring that you submit pay stubs, bank account statements, and tax returns from the past two years.
You also have to speak to a lender and fill out an application, but once the process is complete you’ll know exactly how much you can afford and it puts you in a much stronger buying position from the rest of the homebuyers on the market.
Being preapproved for a home instead of just prequalified stops you from wasting time by looking at homes that are too expensive for you.
Anyone can be prequalified, but it’s the home buyers who are preapproved that have the most power when it comes time to purchase a home and submit an offer.
So what are the main considerations when it comes to determining how much you can afford to spend on a home?
The first thing that a lender will look at is your asset to debt ratio. How much you owe vs how much you owe is a major factor in deciding how much home you can afford.
Traditional lenders allow you to spend 28 percent of your gross monthly income on mortgage payments and 36 percent on the rest of your debts.
If you owe nothing, then you can put the full 64 percent of your income to your mortgage, thus being able to afford a more expensive property.
If your debt falls somewhere in between, then the difference can be applied to the monthly mortgage expense.
Current interest rates also influence the amount of money that you can spend on a home.
If you are locked into a 4 percent interest rate on your mortgage, then you’ll be able to spend four times your income for a home.
That’s why when rates are historically low, houses sell a lot faster, since more people are able to afford much more than they could with high interest rates.
The problem with waiting for low interest rates is that people rarely get loans when interest rates are low. That’s because they’ll play a waiting game to see if rates fall even lower, only to find the lending rates increasing, which diminishes the amount of money that they can spend on a home.
That’s why it’s best to move forward decisively on a home purchase when rates are comfortable enough for you to purchase the home that you want, without delaying to try to receive more.
Let’s say that in a couple years you are unhappy with the amount of interest you are paying on your loan.
Even if this is the case, chances are that you’ll be able to refinance your home or that you’ll want to sell it and move before the life of the loan is finished.
Most people refinance within 5 to 7 years or sell their property and move.
The difference between a quarter-point on an interest rate is very negligible per month and although it adds up over the period of the loan, you probably won’t stay in the property long enough for it to really affect you, and if you do then you can always refinance when rates are lower.
The third factor to determining how much home you can afford is influenced by your credit score.
The home buyers who have perfect or near perfect credit scores get the best rates and terms.
When your credit is poor, you’ll end up with a much higher interest rate, pay much more over the full length of the loan, and have a higher monthly payment.
That’s why it’s important for home buyers to pay off their debt or as much of it as possible and to make sure that they have good credit and take care of any negative issues that are impacting their score, in order to qualify for the best lending terms.
Another way that you can figure out how much home you can afford is by doing the calculations yourself. This is probably the least reliable method when it comes to accurately determining the amount of home that you can purchase, but it will give you a good ballpark calculation if you’re interested in knowing what you can buy right now.
Determine how much you are paying for rent now, then subtract the amount you assume will pay for taxes and insurance per month. Multiply that amount by twelve, and it will give you your annual rent payment. As the interest rate drops lower, you’re able to afford more home.
At 4 percent, you’re able to afford four times your income, which is about the start of most adjustable-rate mortgages (ARMs.)
Now just because you are able to afford that much home, doesn’t mean that you wouldn’t be comfortable on less.
You can be as aggressive or conservative as you’d like, and use the excess money to go towards your other living expenses.
Consider the comfort of yourself and your family when choosing how much of a loan you want to take out on your housing expense. You don’t need to borrow the maximum amount if you have other things that you’d want to do with the money and many times it’s totally unnecessary to spend so much of your income on your home.
Since the amount of debt you have and the interest rates are always changing, the best way to determine how much home you can afford to purchase is with use of calculators and tools available on mortgage lender websites.
If you decide that you’re serious about purchasing a home while you’re calculating how much home you can afford, then many of those same sites can also give you instantaneous loan approvals.
Just remember that you can (and should) still shop around when it comes to finding rates.
When you go to real estate firms, they might attempt to steer your business to a professional that they work with.
Sometimes the rates that these referral partners give you might not be the most competitive.
Convenient yes, but at the end of the day, it might not save you money. If you want to save the maximum amount of money that you can, it’s best to shop around and negotiate on the prices.
The internet makes it a quick process to locate mortgage lenders and find the competitive terms that work best for you.
Because of the internet you are able to quickly receive your credit score, find out how to improve your credit history, apply for a loan, and receive more information about the lending process.
There are many ways to secure funding for a home purchase or refinance your home from different electronic lenders including:
- Large banks and national lenders such as Wells Fargo, Bank of America, and Chase Manhattan
- Local mortgage brokers
- Lending aggregators which help you compare rates from dozens of mortgage lenders
- Auction sites such as eBay
Personally, I suggest going with a local lender. You’ll be able to have a much more personal relationship with the lender. Large banks will take much longer to process your loan.
Are you wondering what’s necessary while qualifying for a loan?
Lenders will want to see 3 months worth of mortgage payments as well as tax and insurance escrow payments. You should have this money saved up and readily accessible before you apply to prequalify for a loan for the best chances of success.
This shows the lender that you are prepared to pay off your mortgage once you begin making payments on your new home.