Your home will most likely be your biggest purchase, so figuring out how much you can afford is a key step in the homebuying process. It’s important to be realistic about what you can afford and making sure you leave room in your budget for unexpected emergencies.
Most lenders will agree that buyers should follow the 28/36% rule. That is, you should spend no more than 28 percent of their gross monthly income on housing expenses, and no more than 36 percent on total debt. Total debts should include, not only your mortgage payment, but also other expenses such as student loans, car loans, credit card payments, etc. Housing expenses are generally summarized as PITI: monthly principal, interest, property taxes, and insurance payments. They can also include any housing association fees.
To understand the 28/36% rule, let’s start with the first half, the 28% of your gross monthly income, also known as the “front-end.” If you expect to pay $1,100 in monthly principal and interest, plus $300 in property taxes and homeowners insurance payments, your PITI costs would be $1,400 per month. Therefore, your household must have a gross monthly income (pre-tax income) of at least $5,000 per month ($1,400 / $5,000 = 28%) to qualify.
The second half of the rule, the 36% of total debt, is called the “back-end.” To determine this, you should factor in all your debt: the PITI mortgage payment and any homeowner association fees, plus credit card payments, car loans, student loans, etc. The back-end percentage can also include any required monthly child support or alimony payments.
Using the example above of a PITI payment being $1,400, let’s also assume you have a $200 monthly car payment and $250 student loan payment. Together, these three payments would equal $1,850 per month and be considered your back-end debt. Taking all this in account now, in order to qualify under the back-end ratio, your gross monthly income would need to be at least $5,139 ($1,850 total debt / 0.36 = $5,138.88).
Along with this low debt-to-income ratio, you’ll also need a high credit score to qualify for lower mortgage interest rates. The effect of the difference in rates may not seem significant at first, but added up over years, could be a lot. For example, a 4% interest rate versus a 4.5% interest rate could be as much as $25,000 over the term of your mortgage.
With mortgage interest rates at an all-time low right now, it’s important to know where your credit scores fall. Obtain a copy of your credit report today and review it for accuracy. If you see any inaccurate accounts or accounts you don’t recognize, contact Legacy Credits to help you dispute them. Catching credit report errors early on can help make your home buying process even easier.