It is agreed by most lenders that the mortgage you can afford to pay should a maximum of 28% of your gross income (income before tax.) This affordable sum includes principal repayments, interest and other monthly costs such as home owners insurance and real estate taxes.

For example, if your annual gross income is $64,000, then your monthly payments should be no more than 28% of $64,000 per year = 0.28 x 74,000/12 = $1,727 monthly. If you earn $40,000, that drops to $933/month.

Also take into consideration the fact that, with a fixed interest mortgage, you will pay the same every month for the term of the loan – say 30 years. Each year, as your income increases, your mortgage repayment will be less of a percentage of your income.

You could therefore consider an adjustable rate mortgage. With this you pay a lower interest rate to begin with, followed by a higher rate later when you are earning more. This can often enable you to purchase a better property. Rather than pay less to begin with, you pay the same for a more expensive home.

If you have some cash to spare when you arrange your mortgage, you can reduce your interest rate by purchasing mortgage points. One point is 1% of the mortgage loan. Thus, if you borrow $100,000 to buy your home, one point will cost you $1,000. This will reduce your interest rate about 0.25%, or $250 per year.

However, if you used the same $1,000 as an additional down payment, you would save only $40 each year at a 4% mortgage rate. Once you have paid the required down payment, therefore, any extra cash you have available might be best used to buy points rather than as an additional deposit.

This would depend upon the initial interest rate, the amount of your mortgage loan and the repayment period. Purchasing points is not always cost effective, but is worth considering. A mortgage advisor will be able to give you advice based upon your own circumstances. This could be one way to reduce your monthly repayments. You can therefore afford a larger mortgage.

What mortgage can I afford when I still have my credit cards to pay off? This is a question only you can answer. Much will depend on the spare cash available each month after making payments on other debts. Credit cards charge up to 4 times more interest than a mortgage loan. It therefore pays to focus on repaying such debts before taking a mortgage.

You can borrow 4 times the dollars with a 3.5% mortgage than with a credit or store card debt at 14%. Let’s say you delay buying real estate for 6 months. What you pay off in credit card interest and repayments would be saving 2 years mortgage interest payments!

So, you are able to raise the down payment required by your mortgage lender. You still have extra cash available that you are considering using to increase that deposit. Use that instead to reduce other debts at higher interest rates. You will then have more available each month to enable you to take a higher mortgage.

These are just two factors that can be used to increase your affordable mortgage. So before you ask “how much mortgage can I afford?” you should first reduce your potential interest payments to a minimum. Interest will form the bulk of your monthly repayment in the early years of your mortgage.

]]>a) How much of a deposit are you able to pay?

b) How much can you afford to pay each month?

The way your potential lender will work out how much to lend you is different to the way you will calculate how much you can afford to pay. Sometimes the lender will offer you more than you expected, and at other times will offer less and leave you unhappy. So what’s the difference? Let’s first look at how you might work out how much you can afford.

Don’t look at your dream home, get the price, and then figure how you are going to afford it. People are very good at making themselves promises to economize, stop going out and eat frugally to afford this fabulous home – but they are also very good at failing to do these things and ending up in serious financial trouble, terminating in repossession and eviction notices.

Work out what you can afford to pay each month without making promises to yourself that you know you will ultimately fail to keep. Take the gross (pretax) income for your household, and you should be able to afford a monthly mortgage repayment of around one third of that. So if you and your partner, say, earn $4,800 between you, then you should be able to afford a monthly mortgage repayment of $1,600.

However, if you have other debts such as credit cards and student loans to pay, you should take these into consideration. If you work to about 40% of your gross income as debt, then that should work fine for you. Keep in mind that you can claim tax relief on your mortgage interest payments so once you agree a mortgage make sure you know how much you are paying each month in interest and how much is coming off the principal.

Lenders evaluate your DTI or debt to income ratio. This is the ratio of your total debts to your income, so if you make $4,800 monthly and have debts of $1,730 your DTI is 100×1730/4800 = 36%.

Your lender splits this into two components: the total DTI and the proportion of that which is connected with your housing. That can include your interest and principal payments, any property taxes, any homeowner’s insurance payments and anything else connecting with buying your home such as any payments to a housing association. If you are renting, it includes your rent and any regular maintenance payments.

No more than 28% of the household’s monthly income should involve the housing component. Also, lenders like to see no more than 36% DTI. So if your household earns $4,800 monthly, you should be given a mortgage if your total debts are no more than $1,730.

Since no more than 28% should be used for housing, you can get a mortgage where your total housing costs, including repayments, insurance, etc, are no more than 28% of your $4,800 = $1,344 ( a bit less than the $1,600 estimate above). That also means that your other debts should be no more than 8% (so all debts = a maximum of 36%) or $384 monthly.

Using that example, you should be able to work out how your mortgage affordability, or much you can spend on your mortgage. Obviously, the lower your other debts, the more you can afford for your home to a maximum of 28% of your total monthly pre-tax income.

That’s the way your lender calculates it, which is not the same as you would have done. It is important to understand how your mortgage lender thinks in order to make sure that you meet their requirements.

To answer the question, ‘How much home can I afford,’ you can work out you mortgage afordability using that $1,344. If the current mortgage interest rate is 4%, and you pay around 2% annually for taxes and insurance, you can afford to pay in the region of $200,000 for your home. You would have to check with your choice of mortgage lender or building society for exact amounts.

We can help you understand how much home you can afford with a FREE consultation. We can also get you up to date on where mortgage rates are and which loan programs fit your needs the best.

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