One of the most common questions¬†a first-time home buyer will ask is "How much home can I afford?"
The answer, as a mortgage lender will tell you, is that "it depends".
There are no concrete rules for how much home you can afford, or how big your mortgage can be.
In part, this is because mortgage lenders determine your maximum home purchase price differently from how¬†you might calculate it yourself via a¬†mortgage calculator.
Both methods, though, take¬†today's mortgage rates¬†into account.
Let's examine them.Click to see today's rates (Dec 10th, 2016)
When you ask a bank to calculate your¬†maximum home purchase price, the bank will give very little consideration to your existing home hunt, or any properties on which you've considered making an offer.
Rather than using¬†a specific sales price, the bank will consider your annual income and your annual debts only.
It will use that data to find¬†the largest mortgage payment you could make¬†without raising your debt-to-income (DTI) ratio above allowable maximums.
Most conventional loans enforce a maximum DTI of 45%, with the exception of the¬†HomeReady‚ĄĘ program, which allows up to 50% DTI.
FHA, VA, and USDA mortgage loans also enforce a maximum DTI near 45%. Jumbo mortgages stop around 40% DTI.
Now, once the bank has found¬†your maximum mortgage payment, it uses current mortgage rates to "back in" to a loan size, which tells you how much you can borrow.
This¬†method of determining how much home you can afford is effective, but dangerous. It's based on borrowing the absolute maximum for which you can get approved, which is often¬†not advisable.
Banks can't¬†tell you what you¬†should pay for a home -- they can only¬†show you what you¬†could¬†pay for a home.
Your debt-to-income is considered¬†in two parts -- the front-end ratio and the back-end ratio.
The first component of the debt-to-income ratio is the "front-end ratio".
Front-end ratio compares the expected monthly housing payment to a buyer's monthly income, where "housing payment" includes all of the following obligations :
There is no maximum limit for a front-end ratio, but lenders prefer to see front-end DTI of 28% or less. This means that¬†banks prefer that 28% or less of your total monthly income be allocated to your housing payments.
You can still be approved with a front-end ratio above¬†28%, but it's a little less usual.
The second component of debt-to-income ratio is the "back-end ratio".
Back-end ratio compares not the monthly housing payments against a buyer's monthly income, and all other¬†monthly payments, too.
Back-end ratio accounts for all of the following monthly obligations a home buyer may have :
In general, banks want to see a back-end ratio of 36% or less, however, having a DTI over 36% will not disqualify your loan¬†application automatically.Click to see today's rates (Dec 10th, 2016)
As a home buyer, you can rely on a bank to tell you how much home you can afford, or you can figure it out¬†on your own.
In¬†many cases, your bank will approve you for a more expensive home than you want to purchase. This is because banks will approve you to your maximum home price, which can generate more fees.
When you purchase at your maximum upper-limit, though, it doesn't leave you with much cash for saving, investing or living -- let alone paying taxes.
Therefore, consider a more personal¬†approach to "How much home can I afford?".
To do this, first, determine the maximum monthly payment you'd like to make each month. This will require thought and attention to your household budget.
Then, using using a¬†mortgage calculator, plug in your desired payment and today's mortgage rates to find the¬†loan size that kind of payment will afford.
For example, if you budget for a monthly housing payment of $2,500 with two percent annually going to taxes and insurance, assuming the current 30-year mortgage rate is 4%, the math "worked backwards" reveals a maximum home purchase price of $385,000.
This method is better at holding you¬†"on budget" as compared to letting a bank set your maximum purchase price.
To answer "How much home can I afford?", ultimately, requires a buyer to know today's mortgage rates. Mortgage rates affect monthly payments which, in turn, affect your budget.
Get today's live mortgage rates now. Your social security number is not required to get started, and all quotes come with access to your live mortgage credit scores.Click to see today's rates (Dec 10th, 2016)
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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2016 Conforming, FHA, & VA Loan Limits
Mortgage loan limits for every U.S. county, as published by Fannie Mae & Freddie Mac, the Federal Housing Administration (FHA), and the Department of Veterans Affairs (VA)