How Much House Can You Afford?

      When you buy a house, there are up-front costs and mortgage payments to consider. Your buying power depends on how much money you have available to put down on a house and on how much a creditor will agree to lend you.   The general rule of thumb is that you should buy a house that costs up to 2 1/2 times your annual gross income, and your housing costs should be about 1/3 of your take-home pay or 1/4 of your gross pay. This should provide some general parameters for the price range of houses to look at, and an approximate amount you might be able to spend on monthly mortgage payments.

  The down payment:

      Coming up with the cash for a down payment is usually the hardest part of buying a home. If you put down less than 20%, you will be  required to purchase Private Mortgage Insurance (This protects the lender's investment in case you fail to make your payments). The larger your down payment, the lower the cost of your mortgage (and, ultimately, the house). So, you'll want to make as large a down payment as you can afford. However, before determining your down payment, consider the following costs associated with your loan:

    1.Closing Costs. These usually total between 3% and 6% of the amount of  your loan, and include points, insurance, various fees, and inspections.

    2.Cash Reserves. Lenders often want to see that you have at least two months of mortgage payments in savings when you apply for your loan.

    3.Miscellaneous Up-Front Costs. Moving into your new home will cause other up-front costs such as moving costs, repairs that the house might need, furnishing, etc. Taking all this into consideration, you should try to come up with a down payment of as much as possible.

  How much can you afford to borrow?

     Consider that your lender will review both your income and existing debt to determine how much mortgage debt you can afford. Two ratios serve as guidelines for lenders in evaluating your loan application.

    1.Housing Expense Ratio: Monthly housing costs (including property taxes and insurance as well as mortgage payments) cannot exceed 28% of your monthly gross income.

    2.Debt-to-Income Ratio: Your total long-term debt (including housing costs, car loans, student loans, alimony or child support, and balances on credit cards that will take longer than 10 months to pay off) should not exceed 36% of your monthly gross income. Lenders feel that these guidelines will keep household debt manageable. However,  they are somewhat flexible. If you make a large down payment, or if you have consistently made rental payments close to the amount of your proposed mortgage payments, you may be able to exceed these guidelines. And some lenders allow low and moderate-income buyers to use 33% of their gross monthly income for housing and 38% for total debt.   A suggestion would be to keep track of what you spend for a few months and then plan for any vacations you want to take, major purchases you'll make, or emergency savings you want to have in reserve. This will help you to know what you can comfortably afford.