How much mortgage can I afford? That is the question I expect everyone planning to buy a home to ask himself first. Just like the Holy book says, “For which of you intending to build a tower, does not sit down first and count the cost, whether he has enough to finish it. Lest after he has laid the foundation, and is not able to finish, all who see it begin to mock him, saying this man began to build and was not able to finish”. This applies to you if you are planning to buy a home. It will be totally wrong to start searching for the property when you don’t know how much mortgage you can afford. This is like putting the cart before a horse. I don’t know how you will feel if after searching for a long time and you finally find a property that you really love but only to discover that you cannot afford to buy the home.
So, if you are asking the question, “how much mortgage can I afford?” you are actually on the right path. That is, you are doing the right thing. There are methods you can adopt to get answers to this question. The first method is to approach a lender to pre-qualify you for a mortgage. That is exactly what Jones Anderson did. He shared his experience with me as follows.
“I had been saving towards my home purchase as far back as when I turned 22. Every month, I made sure I put something into the account I opened for that purpose, no matter how little it might be. By the time I was 25, I had already saved well enough above $45,000. At that time, I was ready to hit the market to start searching for my dream home. My taste is very high. So, I was looking for property in very reserved locations. Finally, I was able to locate the one I actually liked. The asking price for the property was $250,000. This sounded okay for me. I then approached my bank for a mortgage loan so as to enable me buy the property. But unfortunately, I was told that I could not afford the mortgage that can buy the property. I felt devastated. It was at this point I now asked, “How much mortgage can I afford?” After asking me some questions, he was able to pre-qualify me for the mortgage I could afford. At this point. It became clear that I was not ready for the kind of property I dreamed for myself if I should go through the conventional mortgage loan. However, he was able to advise me if I could try FHA loans as this will not require 20 per cent down payment. He said that with my credit score, I will only need to make just 3.5 per cent down payment.” That is just an abridged version of Jones Anderson’s discussion with me. I don’t want to bore you with the details.
Experience is the best teacher. But at times, experience can be the worst teacher. Experience is the best teacher when you learn from the mistakes of others. But if you wait till the time that you learn from your own mistakes, the experience can be a bitter one. That is the main reason I shared the above experience with you. Therefore, before you start your search, you should endeavour to ask yourself or your lender, “How much mortgage can I afford?” The only drawback of mortgage pre-qualification in determining your mortgage affordability is that the lender doesn’t know your financial goals. Therefore, he may not take them into consideration while computing the amount of mortgage loan that you can afford. For example, he may not know the amount you plan to be paying into your emergency fund, retirement account or the number of children you want to have and your financial goals for them. The fact that you are pre-qualified for a mortgage loan amount does not mean that you can actually afford it. You need to take your other financial goals into consideration. You are at a better position to understand yourself. That means you can actually determine how much mortgage you can afford by yourself with the use of mortgage affordability calculator.
So, your question of how much mortgage can I afford can also be answered through the use of mortgage affordability calculator. Although there are other types of mortgage calculator, the mortgage affordability calculator will help you determine the amount of mortgage loan you can actually afford based on the information you supplied.
Mortgage Affordability Calculator
Affordability Calculator by MortgageLoan
What are the factors that determine how much mortgage loan you can afford?
Before it can be concluded that you can afford certain amount as a mortgage loan, certain factors need to be considered. These are discussed below:
Income, debts and other expenses: You must have heard about the 28/36 rule. If you have not, you are probably very new to the real estate market. I will not assume that you understand the rule. That is why I will take my time to explain what the 28/36 rule means in a simple language. But before I do that, let me talk about your income. Your income is the combination of salaries, wages, bonuses, incentives and regular income from investments. This will also include the income of your co-borrower if any. Your income here is usually your pre-tax income. The more income you earn, the more the amount of mortgage loan you will be able to afford. In fact, your income is the starting point for answering the question of how much mortgage you can afford. Another thing that will be considered are your current monthly obligations towards the repayment of your debts and monthly expenses. Your debts include student loans, auto loans and credit card debts. This does not include your proposed mortgage loan. Your monthly expenses will include food, transport, utilities, insurance, and groceries and so on.
With this understanding, I can now explain the 28/36 rule. What it means is that, lenders will expect that your mortgage payment which include principal repayment, interest, insurance and property tax should not be more than 28 per cent of your pre-tax combined income. This is what is called front end ratio. On the other hand, your monthly debts payment divided by your monthly pre-tax income should not be more than 36 per cent. Your monthly debts payment divided by your monthly pre-tax income is known as back end ratio. With these variables, you can actually increase the amount of mortgage loan you can afford by either increasing your income, paying down your debts or both.
Down payment: If you want to buy a home, you should prepare to make a down payment of at least 20 per cent of the purchase price of the property. Otherwise you will be asked to pay for private mortgage insurance and this will add to your costs. However, with FHA loans, you can make down payment as low as 3.5 per cent. The higher your down payment, the higher the mortgage you can afford.
Cash reserves: Besides the initial down payment, you will need to pay closing costs and upfront insurance premium as may apply. Also, if you have enough cash reserves that can take care of your three to six months expenses, this will increase your mortgage affordability. As a homeowner, you may need to carry out repairs and maintenance on your building. These will require money.
Mortgage term: The two popular mortgage terms are 30 years fixed mortgage and 15 years fixed mortgage. How does mortgage term affect your mortgage affordability? You should understand that the longer a mortgage term, the lower your monthly mortgage payment will be. However, you will pay more interest. The 30 years fixed mortgage is actually good for people that intend to borrow large amount. They will be able to spread the payment over a long term.
Credit Score: If you have a very good credit score, you may be able to get your mortgage at a good interest rate. Interest is part of your monthly mortgage payment. If the interest rate on your mortgage loan is low, this will lower the amount of your monthly mortgage repayment amount. And this will increase your mortgage affordability.
HOA Fees: There are some areas where homeowners are under obligation to pay HOA fees. HOA fees means homeowners association fees. This fee is usually paid where there are public amenities which have to be jointly maintained by homeowners in that area. Examples of such amenities include clubhouses, fitness rooms, security gates, parking lots, sidewalks and swimming pools etc. The fee is usually paid monthly. Just as mentioned before, if you are pre-qualified for a mortgage loan, your lender may not consider this. Therefore, you will need to factor it into your calculation in arriving on how much mortgage you can afford.
Property tax: As a property owner, you have the obligation of paying tax on the property. The property tax you will pay will be determined by the local tax authority of the area where your property is located. And this will be based on the appraised value of the property. If the property tax you will need to pay on your home is high, this will reduce your mortgage affordability.