Your salary largely determines how much you can afford to spend on a house. In addition to salary you’ll need to take into consideration other factors when purchasing a home, such as monthly loans and credit card payments. The ratio of your debt to income, in fact, will be a major factor in determining whether you'll be approved for a mortgage loan. And two primary indicators exist to inform you of the maximum house payment you can afford while still maintaining healthy finances.
28 Percent Mortgage Rule
The 28 percent mortgage rule states that your monthly house payment should equal 28 percent or less of your gross monthly income. Financial institutions generally hesitate to approve mortgages when monthly payments exceed 28 percent of gross monthly income. Lenders often maintain that paying more than 28 percent of gross monthly income on a loan increases the chance of default. The 28 percent mortgage rule is a maximum and borrowers should usually aim to spend less in order to protect their financial health.
Once a mortgage lender ensures you meet the 28 percent rule's requirements it will examine your debt-to-income ratio. DTI ratio is a percentage of your total fixed monthly debt in comparison to your gross income spent on credit card payments, other loans and rent or mortgage payments. Lenders prefer DTI be 36 percent or less, according to LendingTree.com. In some cases, though, lenders may approve conventional as well as federally backed mortgages for borrowers having a maximum 43 percent DTI ratio.
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Additional Living Expenses
While the 28 percent rule and debt-to-income ratio guidelines serve as two reliable indicators of the house you can afford, they don’t take into account other expenses. Groceries, daycare, future tuition and health care, for instance, can make it a challenge to meet a large monthly mortgage payment. A family of five, for example, may spend considerably more on daycare and groceries than a family of two or three. Stretching income just to meet a monthly mortgage payment is never a good idea.
Affording an Expensive House
You may still be able to afford a more expensive house even if its payment initially exceeds the 28 percent rule as well as DTI ratio guidelines. A 30- or even 40-year mortgage provides a lower monthly payment than a 15-year product, though the total interest paid is greater. A larger down payment will also decrease your mortgage's monthly payment. Purchasing a home in a different location may also make sense because homes in higher-cost locations are more expensive than comparable homes in lower-cost areas.
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