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How Much Can You Afford?
Your ability to repay your mortgage is a major concern of the mortgage lender. To determine if you qualify for a loan, the lender will consider your credit history, your monthly gross income and how much cash you will be able to accumulate for a down payment. This is generally 5-20% of the purchase price of the home.
Just because the bank is ready to lend you a certain sum does not mean you should take it without consideration. Your spending habits and a large number of other factors should be taken into account in any home-buying calculation.
So, how much can you afford to spend on a new home? To answer this question, you need to know two figures:
How do lenders evaluate your ability to repay the loan?
Your own and the lender's estimates of the maximum loan you can afford may be different.
The maximum mortgage loan amount, which the lender will allow you to take, is determined by the maximum sum you are able to pay each month.
In the United States of America, the lenders calculate this sum according to the commonly accepted 28/36 rule, which is explained below:
Here is an example
Let us assume that the gross annual income for you and your spouse is $60,000 and your only debt is $500 per month on an auto loan. The result of the first calculation (60,000/12*28% = 1,400) would qualify you for a monthly payment of up to $1,400. The second calculation (60,000/12*36% - 500 = 1,300) qualifies you for $1,300 per month.
According to these figures, the maximum loan repayments you can make are $1,300 per month, since this is the lesser of the two figures.
Based upon this $1,300 figure, the maximum loan amount will be slightly over $200,000 at a 6.5% rate for a 30-year term. This loan offer will result in a monthly payment of no more than $1,300.
What if you want a larger loan?
There are three ways you could qualify for a larger loan:
How Much Will Your Down Payment Be?
Lenders usually demand 10-20% of the sale price as down payment. If you are able to pay more, say 30%, then the lender may disregard any past credit transgressions or he approve your loan without verifying your income. If you pay less than 20% down, you will probably have to purchase private mortgage insurance (PMI) to protect the lender.
Closing costs usually amount to 3-4% of the loan amount.
It is highly recommended that, when gathering your money together for a mortgage application, you do not completely drain your savings. Sooner or later, you will face maintenance, repairs or other emergency needs.
Here is an example
Let us take the figures from the maximum loan example above and assume that the sale price is $200,000. With a down payment of 10%, your monthly payment will be $1,137. If you put 20% down the monthly payment will drop to $1,011 and, with a 30% down payment, you will pay only $884 per month.
Down Payment Tips
Tip #1. Prepare the down payment early
It is recommended that you prepare the down payment and keep it intact for at least two months before your mortgage application. The best way to avoid the temptation to spend it is to use a short-term bank deposit.
Tip #2. Hold a garage sale
Perhaps you could manage a larger down payment if you sell unwanted items, such as old furniture, and include the revenues in your down payment. For example, you may have a kitchen set that is not going to fit in your new kitchen. If you don't sell it before moving you might end up having to pay to have it removed. Besides, the more things you sell, or just throw away, the easier and cheaper it will be to move.
Tip #3. Put down more if you plan to stay in for long
If you are moving into the home of your dreams and plan to stay there for decades, then a higher down payment will allow you to spend less on mortgage payments in the future. On the other hand, if you are planning to sell up and move out within a few years, the high down payment may deplete you of savings required for future relocation costs.