Just because you think you can make a certain mortgage payment doesn’t mean lenders will agree. They like to allow only a portion of your income for payments. Here are some ways to estimate the monthly payment you can “officially” afford.
Method 1 – Debt-to-income ratio (DTI). This is the most accurate method, which shows you can cover the mortgage payments while also staying current on car loans, student loans, credit cards and other debt payments. DTI is a ratio of debt to income. If the ratio is too high, that means you have too much debt for the income you produce.
The calculation is DTI = Total Monthly Debt Payment / Gross Monthly Income. Suppose you want to pay $1,600 a month on a mortgage. And you also pay $400 a month for other debt. Your total debt payments come to $2,000 (mortgage + other). If your gross monthly income is $6,000, then your DTI is 33%. (2,000/6,000). In general, 43% is the highest DTI accepted.
Method 2 – The 30% (also 28%) Rule. In this method, multiply your gross income by 30% (or 28%). This is the amount you can hypothetically pay towards your mortgage. This method doesn’t account for your other debt, so it won’t be as reliable as the first method.
Method 3 – The 2.5 approach. Divide your gross income by 2.5. For instance, if you make $5,000 per month, the calculation would be $5,000 x 2.5 = $2,000. This suggests that $2,000 is a safe amount you can commit to your monthly mortgage payment. This is clearly a more liberal method than the 30% rule and also doesn’t account for other payments you must make. Methods 2 and 3 are quick, but you’ll want to go through Method 1 for accuracy.
Use the calculators in this newsletter to help you calculate how much house you can afford. Contact me to get started on house hunting. ~Valerie