The number of renters is going up, as fewer potential homeowners decide to take on the burden of a mortgage.
Many people who don't know they could afford a home fail to calculate their maximum mortgage. If they did, they would find out they could afford one after all.
Once you determine how much house you can afford, you can get on the road to building wealth and owning property.
Here are 5 tips for calculating your mortgage and new home costs.
1. Pay Off Your Debts
Before you start trying to manage how much of a house you can afford, you need to calculate based on how much debt you're currently carrying. If you're paying off two cars, student loans, and rent-to-own furniture, you could find yourself quickly underwater.
Some lenders will calculate your back-end ratio to determine how much you're going to be able to afford. However, that's not going to include your monthly bills, tax payments, or insurance. Figure out which current payments will persist, which will increase, and which will go away.
For example, if you're currently renting a home, you won't be paying that amount anymore. Instead, you'll be paying for a mortgage which is an investment in wealth.
If you've racked up credit card debt in recent years, that won't go into the calculation of how much of a house you can afford. They might consider the minimum payment but they won't think about your total debt, even though you should.
If there are other lines of credit or child support payments that you're obligated to take care of, you need to include these amounts in your burden of costs.
2. Learn Lender's Ratios
When you're calculating how much of a home to buy, you don't need to calculate the home cost, but the mortgage payments. If you're looking at a home that has a high homeowner's association fee, you'll be paying more per month than a home priced the same without that free.
When speaking to a lender, be aware that they will calculate this fee into how much they're willing to lend you. Your lender is going to want to carefully calculate how much debt you can take on, as their ability to recoup costs depend on this figure. When they calculate this amount, they will assume you to be limited to a monthly payment amount that fits comfortably in your budget.
If the loan burden they give you risks to put you underwater, you're more likely to pay them late or not at all if your basic subsistence is on the line. You'll have what's called a "front-end" ratio that calculates your mortgage as a percentage of your income.
That number will be based on the income you get before taxes. If your state or city has a high tax rate, you're going to have to think ahead on your own behalf. There's also a "back-end" ratio which is a complicated calculation that includes your total monthly debt included as a percent of your income.
While there are some industry standards, both figures hover between 28% and 36%, respectively. However, if you have good credit and steady employment, lenders will see you as a safe bet and could loan you more.
3. Figure Out Maximum on the Front End
If your lender uses higher ratios than what the stated industry standards are, calculate on that. All other percentages are more or less arbitrary.
Start by calculating your pretax income down to the month. If you know your annual salary, divide that amount by 12. Take the resulting figure and then multiply it by the ratio or percentage that your lending institution gives you.
For someone with an income of $72,000 a year, you'd find they have around $6,000 per month to work with. From that figure of $6,000, you'd then multiply by the ratio that your lending institution gives you. If it's 0.30 or 30%, you'd get a result of $1,800 per month.
This means that, according to what the lending institution will allow you, you could pay a maximum of $1,800 per month on a mortgage. This figure needs to be considered as a total figure, not just your principal and interest. Any kinds of taxes, insurance, or monthly fees related to owning your property should be applied.
4. Get The Back-End Maximum
You should have a clue as to how much you can afford as your back-end ratio. Take your income again, divide by 12, and then multiply by that bigger back-end figure.
Make sure you subtract monthly debts to figure out your monthly mortgage payments.
If the figure of 36% is what your institution uses, you'll end up with $2,150 on a $72,000 salary. However, if you pay $650 a month for student loans, credit card, and auto loan debt, you'll only be able to afford $1,500.
5. Figuring Other Costs
If you move from rural Vermont to New York City, expect to pay more per year in every way. When you move to a city, there are often city taxes that help pay for infrastructure that you'll use to get to and from work. You may find that they take an unexpected bite out of your check.
If you're moving to a new place and need to hire movers for all of your things, figure in a few extra thousand to get started in your new home. You might need a paint job, an exterminator, or some landscaping before you move in.
Calculating Your Maximum Mortgage Saves Trouble
By determining your maximum mortgage in advance, you can save yourself the trouble of taking on more house than you can afford. When you're struggling with affordability, you're not going to be able to make as many good financial decisions than you could if you were prepared. Making good fiscal decisions can help you plan for your future and live well for years to come.
If you're considering working with a real estate agent, check out our guide for finding a perfect match.