Start With What You Can Actually Carry
Buying a home with a mortgage is often a costly investment, especially if it's your first one. Since this is likely to be the biggest purchase in your life, figuring your mortgage affordability is a fundamental part of the process.
How much mortgage can you afford? It depends on a few key things: your income, your debts, your credit, and how much you can put down. Below is an explanation of how the mortgage application process works and what determines your affordability.
Mortgage Affordability Calculator
When you're looking to buy a home, your first step should be to figure out how much you can afford. A mortgage affordability calculator takes all the important factors into account automatically.
To use one, you'll input your income and your co-applicant's income if you're buying together. Include income from every source — rental earnings, investment profits, alimony. You'll also input your debt payments and living expenses.
The calculator uses these numbers to show you how much mortgage you can afford. You can change your mortgage rate and how fast you pay it down to see the effect on your affordability and monthly payments.
The 28/36% Rule
Be realistic about your monthly income and expected expenses. Leave some room in your budget for unexpected costs or emergencies.
Generally, financial advisors recommend following the 28/36% rule when figuring out your budget. This rule says you should spend no more than 28% of your total income on housing expenses and 36% on your debts. The 28/36% is a time-tested rule that forms the foundation for how much you can afford monthly to service your mortgage.
What Lenders Look At
Different mortgage lenders use their own criteria to determine mortgage affordability, but here are the common factors that may determine how much mortgage you can afford:
1. Gross Income
Your gross income is essentially your base salary plus bonus income. It may also include part-time earnings and Social Security benefits.
2. Front-End and Back-End Ratios
The front-end ratio — also known as the mortgage-to-income ratio — is the percentage of your annual gross income that goes to paying the mortgage monthly. The back-end ratio (debt-to-income ratio) calculates the percentage of your gross income required to cover all your debts.
3. Credit Profile
Your current credit score and the debt you owe influence how a lender sees you. Your credit score impacts how much mortgage you can borrow.
4. Cash Reserve
This is the amount of money you have to make a down payment as well as handle any closing costs.
Down Payment: How Much You Need
Your down payment is the amount of money you can afford to pay out-of-pocket for your home. You can use liquid assets or cash. Most lenders want a down payment of at least 20% of the home's buying cost.
Generally, the higher your down payment, the less financing you'll need, and the more favour you gain from the bank. Lenders also want to know how many years you need the mortgage loan for. Short-term mortgage loans typically require higher down payments but tend to be less costly over the loan's duration.
Fortunately, you don't necessarily need to pay the minimum 20% down payment to access your mortgage. It's easy to get a new home with less cash in hand. You can find programs that make mortgages available with as low as a 3.5% down payment. Different government and first-time homebuyer programs are available for buyers with little to no down payment.
Set Realistic Expectations
There are different ways to determine how much mortgage you can afford from a lender. The mortgage affordability calculator is one of the most commonly used methods to calculate mortgage affordability and determine a budget for your payment.
Lenders also use different factors to assess your affordability. It's essential to set reasonable expectations when calculating your mortgage affordability to avoid getting overwhelmed in debt. Start with what the numbers say you can carry, then ask yourself what feels sustainable month to month — not just doable, but comfortable enough that you can still live your life.
