More mortgage Q&A. This time I address the always popular question, “What mortgage can I afford on my salary?”
Now that we are officially post-mortgage crisis, in most cases you actually have to document your salary/income, as the days of the stated income loan have pretty much come and gone (and for good reason!).
That said, it’s important to determine what size mortgage you can qualify for based on your actual salary, not just the made up numbers your unscrupulous loan officer plugs into the system.
Start with DTI
The best way to accomplish this is by figuring out your debt-to-income ratio (DTI), which is essentially your monthly liabilities (car payments, credit card payments, anything that shows up on your credit report) divided by your gross monthly income (based on the two most recent tax years).
It’s further broken down into a front-end and back-end ratio, with the former being your monthly housing payment divided by gross income, and the latter being all expenses divided by gross income.
A bank or lender may have a DTI requirement of something like 30/45, meaning your housing payment cannot exceed 30 percent of monthly gross income, and all liabilities cannot exceed 45% of income.
So if your monthly gross income happens to be $10,000, the most you’d be able to take on would be a $3,000 housing payment, which includes the mortgage itself, along with insurance and taxes (and mortgage insurance if applicable).
Interest Rates Are a Key Part of the Equation
It’s all good and well to know the dollar amount you can afford, but without knowing where mortgage rates are at, you won’t know a whole lot. If rates are high, your salary won’t go very far. Conversely, if rates are super low, you may be surprised at what you can afford.
After figuring out your DTI, you’ll need to get your hands on a pre-qual or pre-approval letter from a bank or broker to determine what size mortgage you’ll be able to afford based on current mortgage rates.
This is also where your down payment amount will come into play. The less you put down, the larger your loan amount will need to be, and vice versa. Be sure to ask the bank or broker what is required in the down payment department to ensure coming up with the necessary funds won’t be an issue (zero down financing is basically a thing of the past as well).
Once you consider both your down payment and your projected mortgage rate, you’ll be able to determine the maximum mortgage amount you can afford, and then you can begin to focus on the house itself, assuming you’re looking to buy and not refinance.
Check out my mortgage payment tables, which allow you to quickly compare different loan amounts at different rates.
Tip: You may be able to get your hands on a larger mortgage if you find an interest-only option, assuming you’re qualified using the I/O payment, but don’t cut it too close.
With mortgage rates in constant flux, you won’t want to find yourself out of luck if rates swing higher and push your DTI ratio beyond the acceptable limit.
Also be sure that you’re comfortable with the size of your monthly housing payment from an emotional standpoint, and don’t forget about taxes and insurance (and HOA fees), which can add up and account for a significant portion of your monthly housing payment.
So that’s pretty much it – don’t just assume you can afford a certain loan amount, get the numbers in writing from an experienced mortgage loan officer so you don’t encounter any unwelcome surprises while shopping for a home.
Read more: How much house can I afford?