Lenders use a debt-to-income ratio to determine the mortgage amount you can afford. Many prefer to see a ratio no larger than 36%; however, some will allow a ratio between 40% and 50%. Calculate your debt-to-income ratio by gathering two pieces of information: your total monthly gross income and your total monthly debt.
Calculate your debt-to-income ratio by dividing your total monthly debt by your monthly household income. For example, let’s say that your total debt, including the new mortgage, is $2,800. Divide this by $6,600 to get a DTI ratio of 42%. If your lender requires a DTI of 36%, this ratio is too high. But don’t worry; there are steps you can take to reduce it.
If your DTI ratio is too high, you can use a few strategies to lower that number and make it easier to qualify for a home loan. Consider the following:
The total cost of your mortgage extends well beyond the loan amount. A variety of costs are associated with your loan, including:
Principal. The principal is the actual amount you borrow. For example, if you borrow $200,000 to purchase a home, this is the loan’s principal.
Interest. The interest is what the lender charges you to borrow the money. For example, with a 30-year $200,00 mortgage with a 4% fixed interest rate, you’ll end up paying $143,739 in interest over the loan term. In contrast, a 15-year mortgage rate for the same amount will only cost around $66,287 in interest. If you can afford a higher monthly payment and a shorter loan term, you’ll save a significant amount of interest.
Property taxes. Property taxes are assessed by the local authority on an annual basis. For example, let’s say that your annual property tax bill is $3,500. Divide that number by 12, which gives you a payment of around $291 monthly.
Homeowners insurance. A homeowners insurance policy covers a variety of damages, such as from storms, theft, fires and more. The cost of your policy will vary based on your house details and geographic location, but the average homeowners insurance premium in the United States is $1,211 annually, or about $100 per month.
Mortgage insurance. If you make a down payment that is less than 20%, you will likely need to pay private mortgage insurance. The cost of PMI ranges from .55% to 2.25% of the original loan amount annually and is paid on a monthly basis. The good news is that once you have at least 20% equity in the home, you can request that your lender no longer require PMI.
Homeowners association fees. Homeowners association fees can vary drastically but are typically between $100 to $700 monthly. Fees vary based on what the association provides, which may include a pool, recreational areas and yard maintenance services. Just keep in mind that this fee will affect your DTI ratio.
A mortgage calculator allows you to input different numbers to determine the best scenario for your situation. A few strategies to lower your monthly mortgage payments include:
If you haven’t owned a house in the past or if your circumstances have changed since your most recent prior purchase, it can be difficult to know what you can afford. A calculator can help you run different scenarios so you can make any necessary changes to accomplish your homeownership goals.