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Basics of Buying a Home
Are you ready to buy a house? How much can you afford? Answering that second question may not be so easy. Before you snap up that seemingly great buy on a home, learn how to analyze what “affordability” means. You’ll need to consider various factors, ranging from the debt-to-income (DTI) ratio to mortgage rates.
Understand Your Debt-to-Income Ratio First
The first, and most obvious, decision point involves money. If you have sufficient means to purchase a house for cash, then you certainly can afford to buy one now. Even if you can’t pay in cash, most experts would agree that you can afford the purchase if you can qualify for a mortgage on a new home. But how much of a mortgage can you afford?
The 43% debt-to-income (DTI) ratio standard is generally used by the Federal Housing Administration (FHA) as a guideline for approving mortgages. This ratio is used to determine if the borrower can make their payments each month. Some lenders may be more lenient or more rigid, depending on the real estate market and general economic conditions.
A 43% DTI means all your regular debt payments, plus your housing-related expenses—mortgage, mortgage insurance, homeowner’s association (HOA) fees, property tax, homeowner’s insurance, etc.—shouldn’t equal more than 43% of your monthly gross income.
For example, if your monthly gross income is $4,000, you multiply this number by 0.43 to get $1,720, which is the total you should spend on debt payments. Now, let’s say you already have these monthly obligations: minimum credit card payments of $120, a car loan payment of $240, and student loan payments of $120—a total of $480. That means, theoretically, that you can afford up to $1,240 per month in additional debt for a mortgage and still be within the maximum DTI. Of course, less debt is always better.
Can You Afford the Down Payment?
It’s best to put down 20% of your home price to avoid paying private mortgage insurance (PMI). Usually added into your mortgage payments, PMI can cost between 0.5% and 1% of the entire mortgage loan amount annually.
A smaller down payment won’t mean that it’s impossible to purchase a home. You can buy a home with as little as 3.5% down with an FHA loan, for example, but there are bonuses to coming up with more.
The Bottom Line
Are you ready to buy a house? In short, yes—if you can afford to do it. But “afford” isn’t as simple as what’s in your bank account right now. A host of other financial and lifestyle considerations should figure into your calculations.
When you factor in all these elements, “if you can afford to do it” starts looking more complicated than it first appears to be. But, considering them now can prevent costly mistakes and financial problems later. Of course, there is one best time to pounce: when you find the perfect house in the perfect place for sale at a perfect price.