Are you thinking about buying your first home? If so, I don’t want you to be one of the over 7,000 people that default on their mortgage in three or more months because of lack of knowledge. To answer the question how much can I afford, you need to look at several factors and understand the important factors lenders use when giving mortgages.
Stick to the end of this video where I will share how to determine your debt to income ratio and how much down payment you can afford which will help you secure a mortgage with a good rate and prevent you from default
Debt To Income Ratio
Let’s get into it by looking at the debt to income ratio. This is one of the most important factors when it comes to securing a mortgage when buying your first home. What is debt to income ratio, also known as DTI, and why is it so important? Basically it determines how you can afford to pay. It takes in account all your debts, monthly mortgage payments and your income to provide the percentage of how much of your income is going towards paying your debt. The lower your DTI the better. Lenders tend to want a DTI of 44% or less.
Let’s look at an example.
Sally has a gross monthly income of $4,000.
She has a credit card with a monthly payment of $120
Car loan payment of $240
Student loan payment of $120
Mortgage payment of $2000
In total Sally has $2480 of monthly debt payments.
To find out Sally’s debt to income ratio we will take her monthly debt payments and divide it by her monthly income. Her debt to income ratio is 62%. Which is too high. The lower the debt, the better.
What Mortgage Lenders Want
Ok, let’s look at what mortgage lenders want. Lenders will look at your debt to income ratio as well as your front-end debt to income ratio. This is important for you to know when you are buying your first home.
Your front end DTI also known as mortgage to debt ratio or gross debt service includes income and the mortgage payment only. And lenders are usually looking for no more than 39% and this is regardless if there is other debt or not. Lenders want to make sure there is wiggle room in case there is an unexpected emergency.
Let’s look back at Sally, remember her income was $4000 per month and her mortgage payment was $2000. Her front-end debt is 50%, which once again Sally’s ratios are too high.
Once again, the lower the debt, the better. So if you are looking to buy a house in the near future, start paying off as much of your debt as possible. The easiest way to do that is through the snowball effect, if you would like us to make a video on the snowball effect let me know in the comments below.
I promised we would look into down payments. I’m not going to go into full detail about down payments because we have another video for that. If you have watched it, pause this video and watch that video before continuing. The link will be in the description.
To avoid mortgage insurance you need to put down at least 20%. Mortgage insurance can be another 2.8% on your mortgage. But sometimes we can’t put down the full 20% and that’s ok. There may be reasons why you might not want to put down 20%. You can still buy a home with less than 20% down payment, but putting down 20% will lower the monthly payment, which means smaller payments.
Remember the goal is not to only be able to afford a home today but most importantly that you are able to afford it for the long haul.
If you are thinking about buying a house in the near future and have questions on the process, how to get started, or want to position yourself to buy in the future we’ve been more than happy to help you reach your goals, contact us anytime. I will see you in the next video. And remember building generation wealth is for everyone.