How much house can you afford?
Purchasing a home is an exciting time, but it can also be a daunting task. Mortgage rates, available inventory, inflation and local conditions are all factors that impact housing prices. Economic volatility fluctuations have made homeownership out of reach for many people. But today the real estate market is shifting, and prices are beginning to soften, leading many to wonder: Is today the day to put in an offer?
“The right time to buy is different for everyone,” said Todd Farley, senior vice president, mortgage sales and production manager for Commerce Bank. “Interest rates are rising, and some price points have softened; but demand for entry-level homes is still there. It’s important for buyers to know their price point, work with a lender to get preapproved and be prepared to act quickly.”
Understanding how much you can afford may be the most critical question when house hunting. It impacts your price range as well as both your monthly and long-term costs as a homeowner. So how do you determine how much mortgage you can afford — and will a lender say you’re eligible?
Budget concerns: what to keep in mind.
To get a general idea of your budget as a homeowner, start with your monthly income. A good rule of thumb is to allocate no more than about a third of your monthly earnings on housing costs.
“When transitioning from renting to owning, it’s more than just a rent payment,” Farley said. “There are many additional expenses that come along with owning a home.”
It’s always a good idea to set aside savings for routine maintenance and unexpected costs if something breaks down, such as a furnace or kitchen appliance. In addition to furnishings, there may also be additional things you may need to buy for your home that you probably wouldn’t need as a renter, such as a lawn mower or garden hose. And, of course, there are recurring costs. These include utilities (and deposits to open the accounts), HOA fees when applicable, origination and inspection fees, homeowner’s insurance, property taxes, private mortgage insurance (PMI) and more.
“PMI is an insurance policy that insures the homeowner against default to the lender,” Farley said. “But it does have some benefits for the borrower, too. For example, if you were to lose your job or have a significant life event, your carrier will have an interest in providing resources to help you keep your home.”
Talking with a trusted advisor or using a mortgage rate calculator can help you determine monthly payments, find out how much you might qualify for and even compare between different loan types.
How lenders determine how much you can afford.
Lenders don’t just look at your income; they also take into consideration the liabilities and obligations you have. First and foremost is your credit score. They’ll want to make sure you’re good at managing your debt, so having a higher score may help you qualify for a lower interest rate and potentially a larger loan amount. If your credit score isn’t where you want it to be yet, consider spending time increasing it before you apply for a mortgage. Reducing debts, disputing errors on your credit report and getting current on late payments can help.
Lenders also look at your credit history (including bankruptcies and foreclosures) and your debt (including other loans you have, such as a car loan). Your debt-to-income ratio (DTI) compares much you owe each month to how much you earn. When it comes to your assets, not every type counts: Lenders are more interested in liquid assets, such as money in a savings, Roth IRA, stocks or money market account.
“Your history of steady income also matters,” Farley said. “We’re in a unique environment where there’s a lot more gig economy income. A lot of times this can be counted, but you have to prove a history of it.”
A conventional loan is made through a private lender, such as a bank, credit union or mortgage company. These types of loans require a minimum of a 3% down payment and sometimes offer a lower interest rate, but you may need a higher credit score to qualify.
A 20% down payment is widely considered the ideal amount for most loan types and lenders, but it’s not a requirement. Benefits of being able to put at least 20% down include better interest rates, lower monthly payments and you can avoid paying for PMI. But if you don’t have that amount, don’t worry. There are many options available to help home buyers, including down payment assistance.
Assistance for purchasing your home.
Down payment assistance programs and grants are just some of the options available when you’re looking for a new home. A Federal Housing Administration (FHA) loan, VA loan or USDA loan can all be good places to start looking.
“These can be great options for home buyers,” Farley said. “They’re all backed by the government. Nearly everyone is eligible for a FHA loan, but there are some requirements with VA or USDA loans.”
HomeReady® is another possibility when other options may not be available. It’s an affordable mortgage program for first-time buyers that’s also available to repeat buyers and existing homeowners for a refinance, but it may have some limitations based on geography and income.
“Commerce is a fair housing and equal housing lender,” Lori Roesler, marketing strategy manager – consumer loans for Commerce Bank, said. “That means we offer solutions for all income levels. Neighborhood Connection™, for example, is offered in the Kansas City, St. Louis, Houston and Wichita areas and assists those with low to moderate incomes.”
If you’re looking to buy now while rates are still relatively high, refinancing in the future may be one way to lower your rate.
“Last year, mortgage rates rose rapidly, more than doubling to reach highs we haven’t seen since 2008,” Max Vosburgh, senior vice president, secondary market manager for Commerce Bank, said. “Customers who have purchased a home at these high rates will want an easy way to take advantage of a lower rate environment when that happens.”
Discount points, also known as a buydown, are another way to lower your monthly payment and interest rate. If you’re planning on living in your home for a long period of time, and therefore keeping the loan for a long period of time, it can be a way to realize significant savings.
“Your financial situation will determine if it makes sense for you,” Vosburgh said. “You’ll have higher fees up front with discount points, but you’ll have a lower monthly payment thereafter.”
Additionally, both Kansas and Missouri have state legislation that allows first-time buyers to get tax breaks on the money saved for a home purchase.
“If you’re saving money for a down payment on a home, you may be able to deduct a certain amount from your taxes for that purpose,” Roesler said. “Consult your tax advisor to see if you could be eligible for tax benefits in your state.”
The bottom line.
Purchasing a home — whether for the first time or not — is an exciting time and may be one of the largest purchases you’ll make. Everyone’s financial situation is unique, and there is no one-size-fits-all solution when it comes to how much you can afford. Talking to a knowledgeable mortgage banker can help guide you through the process and take the guesswork out of it.