By: State Bank & Trust (Member FDIC and Equal Housing Lender)
All three families taking part in The Forum’s Financial Fix-up are working to get their finances back on track. They may not be looking for a new house now, however, moving could be in their future (whether it’s downsizing when their kids move out, or upgrading when they are back to being financially secure). Maybe you’ve been browsing the real estate section, looking for your next home?
Housing is the largest expense in most families’ budgets. But how much home can you afford?
Rent vs. Buy
Should you rent or should you buy a home? With home mortgage interest rates near 40-year lows, the question to rent vs. buy may be popping into your head. It takes more than looking at your mortgage payment to answer this question. This calculator helps you weed through the fees, taxes, and monthly payments to help you make a good financial decision.
Buying a Home
First, it is important that you plan your budget and how much you would be comfortable paying each month.
The next step is to find a good mortgage lender. They will assist you with the pre-approval process and determine how much you can afford. Lenders determine this by reviewing your credit report and calculating your debt to income ratio (or DTI ratio). This measures how much of your income goes toward debt every month to estimate how much you can afford to borrow to pay for a home. To find this ratio, divide your monthly debt payments by your gross (pre-tax) income. (For example, if you pay $300 toward debt every month on a $3,000 income, your DTI ratio is 10%.) The lower the number, the better.
- Front-end DTI ratios (sometimes called housing expense ratios), which include your total housing expenses: mortgage principal, interest, taxes, and insurance.
- Back-end DTI ratios (also known as total expense ratios), which include all of the above plus other debt payments like auto loans, student loans, and credit cards.
(It’s important to note that daycare is one expense that it not considered a front-end or back-end DTI ratio. This bill can be close to $1,000/month for some people).
It’s also important to note that the DTI ratio estimates the lender’s risk, not yours. The ratio determines whether you can make the payments, not if you can make the payments and have money leftover. So, it’s important that you factor in daycare, miscellaneous expenses, vacation and “fun” money into the equation. Your best bet is to have the DTI ratio you use be lower than the one you are given.
Once you have been pre-approved you can find a good realtor and start looking for your future home.
Here are some ways to tell if you’re ready to buy:
- Good credit report
- DTI ratio is low
- Job stability
Ultimately when figuring out how much home you can afford, it comes down to what you’re comfortable paying. Good luck and remember that you can always seek professional advice from mortgage experts, such as those at State Bank & Trust, before making one of the most important financial decisions of your life.