If you're ready to buy a house, consider what is involved in budgeting for a mortgage. There's more than just the price of the house involved. You have to factor in all the costs associated with a house payment like interest, taxes and homeowner's insurance. Based on general lending guidelines, you can calculate how much of a monthly payment you qualify for. That will help you determine how much your loan amount will be and, depending on how much money you have saved for the down payment, what price range you can start looking at.
Figure out how much of a monthly payment you can afford on your current income. Typically lenders will only allow 28 percent of your gross income to go toward a mortgage payment. If your gross monthly income is $4,500, then you should be able to afford a mortgage payment of $1,260. This amount must account for taxes and insurance in addition to principal and interest.
Calculate what portion of your payment will go towards taxes and insurance, also known as escrow. Tax amounts can vary from .5 percent to 2 percent of the home's value and insurance can cost between .25 percent and .5 percent of the value. Because you don't yet know the value of the home you'll buy, you need to estimate for budgeting purposes. The escrow portion of a mortgage payment runs about 25 percent of the total payment. Using the example of $1,260, that would make your escrow $315 and your principal and interest $945.
Estimate the total mortgage amount your mortgage payment will afford you. The actual amount will depend on what interest rates are when you apply for a loan. For estimating purposes, calculate principal and interest payments at 7 percent of the loan amount. For example, multiply $945 by 100 and divide the amount by 7. This would give you a mortgage amount of $135,000.
Make a list of your current monthly debt. Don't include your current housing expenses, but do list your estimated mortgage and escrow payment along with car and other debt payments including medical bills, alimony and child support.
Add up your expenses, then divide it by your gross income. For example, if your debt payments total $600, your estimated mortgage and escrow is $1,260 and your income is $4,500, your debt is just over 41 percent of your income. Even though the mortgage payment is in line with your income, the total debt to income ratio is a bit high for most lenders. Your mortgage lender will want to see that your total debt to income doesn't exceed 36 percent of your gross income.
Reduce your debt to bring your debt to income ratio into line. In the example, you'll need to reduce your total monthly debt payments, including your projected house payment, to 36 percent of your $4,500 gross monthly income, or $1,620, so you'll have to cut $240 from your expenses. Start with paying off debts with the lowest balances. Consider a consolidation loan for remaining, higher balance debt.
Calculate the amount of money you'll need for a down payment on your house. That may be subject to the type of loan you're getting, but it shouldn't be more than 10 percent, or $13,500 in the case of a $135,000 example.
Figure out how much you'll need to save in order to buy a house. If you already have the down payment amount in savings, you'll be able to start looking at houses right away. If you only have $10,000 saved, for instance, you'll need to put away another $3,500. You can spread that total out over however many months it will take you to comfortably save that amount of money. You'll have your down payment money saved in just six months if you put $584 into your savings account monthly.
The 36 percent debt to income ratio applies to conventional loans. If you are applying for a different type of loan, such as a VA or FHA loan, you may be allowed a higher ratio.
Taxes and insurance are "moving target" amounts that can change. If they go up, so will your mortgage payment to accommodate an escrow shortfall.
If your down payment is less than 20 percent or if your loan-to-value ratio is above 80 percent, you'll likely have to pay mortgage insurance. This can add 0.5 percent of the loan's value per year to your payment.
Lenders don't look at items like groceries, clothing allowance, eating out, utilities and vacations, but those are expenses that you shouldn't overlook when creating a budget.
- Budget and Banking Math; Lucia McKay, Ph.D. and Maggie Guscott
- The Only Budgeting Book You'll Ever Need; Tere Stouffer
- Bankrate.com: How Much House Can You Buy?
- Drafting and Design for Architecture and Construction; Dana J. Hepler, et al.
- Personal Finance Planning; Lawrence J. Gitman, et al.
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