How Much Home Can I Afford?

Most of us, when shopping for a new home, want the largest house possible, in the nicest neighborhood, with all the amenities. After all, this is part of the American Dream! But when the time comes to qualify for a home loan, you may discover that there are conditions on how much you can borrow, and you may hear the term 'debt- to-income ratio' when applying.

But what is debt-to income, and how does this ratio affect your qualifying for a mortgage? Here, we'll help you better understand what it is, and how lending institutions determine it. Understanding your debt-to-income ratio can help you as well before approaching lenders, since you will be more realistic about the type and amount of loan that you qualify for.

Basically, your debt-to-income ratio is calculated by taking the amount of debts that you pay each month, such as credit card bills, car loan payments, and other outstanding debts (but this does NOT include your mortgage or rent) and dividing this number by the your net monthly income (how much you earn each month from all income sources, minus the taxes that are withheld).

For instance, if you earn $3500 a month, and you have $575 a month in car loan and credit card payments, you would divide your monthly debt ($575) by your monthly income ($3500). This equals 16 %, which is your debt-to-income ratio.

Between 16% and 19% is considered an average debt-to-income ratio. In general, most lenders consider a debt-to-income ratio of less than 20% a safe zone, because a higher ratio means that you are becoming overextended financially, and could have difficulty paying off the loan. The lender's goal is to ensure that they get paid back for their investment when they lend you money, and they will hesitate to offer a loan to someone who is overextended.

If your income-to-debt ratio is higher, you may still be given the loan, but you will be considered a higher credit risk. To avoid the hassles of high debt ratio loan rejection, consider using our network of lenders that specializes in helping those with high debt ratio, bad credit or past bankruptcy.

It's important to realize that your debt-to-income ratio does not include monthly expenses such as insurance payments, food, childcare, or clothing; it only covers outstanding loan and/or credit card debts. It's important to look at your overall financial health, and take into consideration other expenses that you face as well, when deciding on how much loan you personally can afford. Also, remember to add in house insurance and taxes when figuring out how much you pay each month (this is known as the PITI, or Principal, Interest, Taxes, and Insurance) when deciding how much loan you can afford.

In general, your total monthly payments for your mortgage should not exceed 28% of your gross income. But it's important to remember that bad credit lenders will have different criteria. Your residual income (the amount of money that you have left after all your monthly housing expenses are paid) should be enough to pay your other debts, and allow you to live comfortably as well. By meeting these criteria, you can get a loan that will help you get that home you've always wanted-without overextending yourself financially.