There are several major concepts you might be thinking about as you prepare to apply for a mortgage and enter the homebuying world, and one of the most important for most buyers is how much they can afford to pay for a home. While making this decision, a number of different factors may influence your thinking — and knowing which to place the most weight on can be very helpful.
At Altius Mortgage and our partners with Mortgage Ogden, our team of quality loan officers offers numerous services to clients in Provo and other parts of Utah, including helping clients evaluate their finances to determine how much they can reasonably spend on a home. Here are some of the key variables that will influence this decision.
Naturally, as you may have expected, income will play a very important role in deciding how much you can afford to pay for a home. In general, most financial advisors recommend that your mortgage payment not exceed 28% of your gross monthly income. However, this is just a guideline — some people may be able to afford more, while others may need to stick closer to 20%.
As you’re evaluating your income, it’s important to think not just about your current situation, but also about realistic projections of the future. If you’re just starting out in your career, you may not be making as much as you eventually will. On the other hand, if you’re close to retirement, your income may start to decline soon.
Now, there are limits to this and you have to be as realistic as possible. You can’t simply assume you’ll eventually make 10 times what you’re making now, or that your income will fall to zero in retirement. However, if you have a good reason to believe your income will change significantly in the future, it can be worth factoring that into your decision.
Cash Reserves Available
While you obviously won’t be paying your entire home price all at once (that’s what your mortgage is for, after all), there are a few major up-front expenses you’ll need to be able to cover. These include your down payment, closing costs, and any necessary repairs or renovations.
In addition, it’s always a good idea to have some cash in reserve in case of unexpected expenses. Most financial advisors recommend having enough cash saved up to cover 3-6 months’ worth of living expenses, but this will obviously vary based on your individual circumstances.
As you’re considering your savings, keep in mind that you may be able to tap into other sources of funding, such as gifts from family members or a home equity line of credit. However, it’s always best to assume you’ll need to cover these costs entirely out of your own savings, just to be safe.
Your debt-to-income (DTI) ratio is another key metric that lenders will look at when considering your mortgage application. This ratio essentially measures how much of your income is dedicated to making debt payments each month, and it’s a good way to get a sense of how much additional debt you can reasonably handle.
Lenders typically like to see a DTI ratio of 36% or less, but again, this is just a guideline. Some people may be able to handle a higher monthly mortgage payment if they have a low DTI ratio, while others may need to stick to a lower payment even with a strong DTI.
Your credit score is another important factor that will influence how much you can afford to pay for a home. In general, the higher your credit score, the more favorable terms you’ll be able to get on your mortgage. This could mean a lower interest rate, which would reduce your monthly payment, or a higher loan-to-value ratio, which would increase the amount you’re able to borrow.
Of course, your credit score is just one factor that lenders will consider when reviewing your mortgage application. They’ll also look at things like your employment history and income level. However, all else being equal, a higher credit score is a good thing.
Your Risk Tolerance
Another major factor to consider when deciding how much you can afford to pay for a home is your risk tolerance. This essentially refers to your willingness to take on financial risk in pursuit of a potential reward.
For example, let’s say you’re looking at two homes that are identical in most ways. Home A costs $200,000, while Home B costs $220,000. If you’re risk-averse, you might be more inclined to go with Home A, even though it means sacrificing some of your desired features.
On the other hand, if you’re willing to take on a bit more risk, you might decide to go with Home B. The higher price tag means there’s a greater chance you’ll end up “underwater” on your mortgage (owing more than your home is worth), but it also means you’ll have the home you really want.
As you can see, there are a lot of factors to consider when deciding how much you can afford to pay for a home. Ultimately, the best way to figure out what’s right for you is to sit down and evaluate your financial situation. Consider things like your income, savings, debts, and credit score, and use that information to arrive at a number that you’re comfortable with.
For help with this or any of the other important parts of obtaining a mortgage and owning a home, or to learn about any of our mortgage rates or other home loan services in Provo or nearby areas, contact our experts at Altius Mortgage today.