Deciding How Much You Can Afford - Pacific Pointe Properties

The 28%/36% Rule

To calculate ‘how much house can I afford,’ a good rule of thumb is using the 28%/36% rule, which states that you shouldn’t spend more than 28% of your gross monthly income on home-related costs and 36% on total debts, including your mortgage, credit cards and other loans like auto and student loans.

Example: If you earn $5,500 a month and have $500 in existing debt payments, your monthly mortgage payment for your house shouldn’t exceed $1,480.

The 28%/36% rule is a broadly accepted starting point for determining home affordability, but you’ll still want to take your entire financial situation into account when considering how much house you can afford.

Key Factors

Key factors in calculating affordability are 1) your monthly income; 2) cash reserves to cover your down payment and closing costs; 3) your monthly expenses; 4) your credit profile.

  • Income – Money that you receive on a regular basis, such as your salary or income from investments. Your income helps establish a baseline for what you can afford to pay every month.
  • Cash reserves – This is the amount of money you have available to make a down payment and cover closing costs. You can use your savings, investments or other sources.
  • Debt and expenses – Monthly obligations you may have, such as credit cards, car payments, student loans, groceries, utilities, insurance, etc.
  • Credit profile – Your credit score and the amount of debt you owe influence a lender’s view of you as a borrower. Those factors will help determine how much money you can borrow and the mortgage interest rate you’ll earn.

Debt-to-Income Ratio

Lenders calculate your debt-to-income (DTI) ratio by dividing your monthly debt obligations by your pretax, or gross, income. Most lenders look for a ratio of 36% or less, though there are exceptions, which we’ll get into below.

DTI sometimes leaves out monthly expenses such as food, utilities, transportation costs and health insurance, among others; lenders may not consider these expenses and may approve you to borrow more than you’re comfortable paying. So keep these additional obligations in mind as you evaluate how much you’re willing to pay each month.

You’ll want the lowest DTI possible not just to qualify with the best mortgage rates and buy the home you want, but also to ensure you’re able to pay your debts and live comfortably at the same time.

Front End Ratio

  • Also known as a household ratio, front-end DTI is the dollar amount of your home-related expenses — your future monthly mortgage payment, property taxes, insurance and homeowners association fees — divided by your monthly gross income.

Back End Ratio

  • Your back-end DTI includes all the other debts you pay each month — such as credit cards, student loans, personal loans and car loans — in addition to home-related expenses. Back-end ratios tend to be slightly higher, since they take into account all of your monthly debt obligations.
While mortgage lenders typically look at both types of DTI, the back-end ratio often holds more sway because it takes into account your entire debt load. Lenders tend to focus on the back-end ratio for conventional loans— loans that are offered by banks or online mortgage lenders rather than through government-backed programs. If your front-end DTI is below 28%, that’s great. If your back-end DTI is below 36%, that’s even better.  When you’re applying for government-backed mortgages, like an FHA loan, lenders will look at both ratios and may consider DTIs that are higher than those required for a conventional mortgage: up to 50% for the back-end ratio.  Ideally, though, you’ll want to keep your DTIs as low as possible, regardless of lenders’ limits. A lower DTI will help your credit score, which will help you to get a lower mortgage interest rate.

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