Owning a home is often seen as the realization of the American dream. Homeownership in the United States, which is the percentage of homes owned by their occupants, is around 65%. In 2021, more than a third of all homebuyers were first-time buyers.
Whether you are a first-time buyer or looking to upgrade or downgrade your property, there are many things to consider. One of these is simply “Can you afford a house?” based on your current financial situation. In this blog post, we will highlight everything you need to know about affording a house.
This includes the factors to consider, the 28/36%, the impact of credit score and debt-to-income ratio, and tips on how to improve your home affordability. Let’s get started!
Factors to Consider When Buying a House
First of all, there are a number of factors that will help you to determine how much house you can afford. Let’s take a look at each of these in turn.
Income
This is money that you receive on a regular basis, whether from your salary or income from investments. Your regular income will help you to establish a baseline of how much you can afford to pay each month.
Cash Reserves
Your cash reserves will enable you to make a down payment and cover any associated closing costs. This money may be obtained from investments, savings, or other sources.
Credit Profile
A credit score is a number that rates a consumer’s creditworthiness. Your credit score and the amount of debt you owe will have an influence on a lender’s view of you as a borrower. This will determine the amount of money you are able to borrow and the interest rate that you will earn.
Expenses and Debt
Consider your monthly obligations, such as utilities, insurance, car payments, credit cards, student loans, and groceries to determine how much money is already tied up.
Crunch the Numbers
When planning to buy a house, you should start out by crunching the numbers taking into account the above information. First, determine how much both you and your partner (if applicable) earn each month.
Then, list your estimated housing costs (such as property tax, estimated mortgage interest rate, and homeowners insurance costs) and your total down payment. Also, determine how long you want to pay off your mortgage (30 years is a popular choice).
Finally, tally up your expenses, which is the money that you pay out on a monthly basis. Crunching the numbers will give you an understanding of how much you can afford to spend on a house.
Click this link for a handy deposit calculator.
Follow the 28/36% Rule
We recommend that you follow the 28/36% rule when determining how much house you can afford. This means that you should not spend more than 28% of your gross monthly income on housing expenses and no more than 36% of your gross monthly income on total debt. This rule helps people to establish a baseline for what you can afford to pay each month.
Let’s take a person with a monthly income of $5,000 as an example. 28% of $5,000 is $1,400, which means that is the maximum amount their mortgage payment should be. 36% of $5,000 is $1,800, which means that their other debts should not exceed that amount each month.
With the rest of your income, you should set a budget to pay for other living essentials, such as transportation, food, entertainment, and savings.
How Does Credit Score Impact Affordability?
You should consider your credit score as the foundation of your finances. It plays an important role in determining your mortgage rate.
To give an example, let’s look at a $400,000 property where a person has a 20% down payment. With a good credit score of 740, they would be available for a rate of around 4.375%. However, if a person has a lower credit score of, say, 640, their rate may be higher than 6%.
Below, we will highlight some tips to help you improve your credit score.
How Does Debt-To-Income Ratio Impact Affordability?
When applying for a mortgage, lenders will also look at your debt-to-income ratio. The higher a person’s debt-to-income ratio, the greater doubt a lender will have about their ability to repay the loan.
You can determine your debt-to-income ratio by adding up your monthly debt and dividing it by your gross monthly income.
How to Improve Your Home Affordability
Here are some practical tips that will help you to improve your home affordability.
Improve Your Credit Score
Improving your credit score will help you to get a lower mortgage rate. To do this, pay down your credit cards and do not apply for additional accounts.
Come Up With a Bigger Down Payment
It stands to reason that the more money you are able to contribute upfront, the less you will have to borrow.
Improve Your Debt-To-Income Ratio
You can improve your debt-to-income ratio by paying off your debts, such as recurring debts like car payments and student loans as well as your credit cards.
Determine How Much Space You Need
It’s worth taking some time to consider how much space you really need. For example, first-time homeowners who aren’t ready to have a family can always start small and find a bigger home when they are ready.
Consider More Affordable Locations
If you are struggling to afford a house in a specific location, it’s worth casting a wider net and opening yourself up to areas where house prices are more affordable.
Can You Afford a House?
The above information will help you to determine how much of a house you are able to afford. It’s important that you take the time to consider your income and expenses and determine the exact amount you can afford to spend on monthly loan repayments.
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