How to Estimate What Home Payment Amount Fits Your Budget
Finding your dream home and putting in an offer is such a satisfying experience. But getting to that point in the home-buying process has its fair share of steps that can take time and careful consideration. One of the first and most important of these steps is to determine a mortgage payment that fits comfortably with your budget.
Every homebuyer has their own comfort level when it comes to house payments. You might be preapproved for an amount with monthly payments that end up straining your budget, so getting organized and assessing your financial situation ahead of time can help you not only while you’re shopping for homes but for the entire time you’re making your mortgage payments. To help you better understand what you can spend on your home, we’ll go over the essentials you need to know in order to settle on a mortgage payment that works for you.
Creating a Budget and Tracking Household Expenses Is a Great Place to Start
To determine a mortgage payment you can comfortably afford, start by taking a deep dive into your budget. You’ll first want to write out the income you have coming in, including all regular sources of it. Use the net figures of these numbers so you’re seeing your true income amounts after taxes. Next, list all your fixed expenses. These are payments you make at regular, predictable intervals, such as rent, utilities, different forms of insurance and your car or student loan repayments. These amounts typically don’t change, and you’ll continue making periodic payments until the loans are done or you pay them off with a lump sum.
Next, your variable expenses will also go into your budget. These are things that are easier to modify or that have more potential to change, such as gas and transportation costs, grocery costs and any spending on entertainment. Some of these may remain the same from month to month, such as streaming subscription prices, but it can be helpful to include them here for several reasons. After you write everything out, you might be surprised to see you’re paying for two different music subscriptions you don’t even use. Variable expenses generally make up a type of spending where you can more easily start cutting back if you determine you need to save more money.
At this point, tally up all your income amounts and all your expenses separately. Then, subtract the expense total from the income total. Once you see what you have left, you can start to address your other debts, your credit score and any future savings you’d like to account for.
The 30% Rule Provides an Effective General Guideline
One of the first ways to start narrowing down an affordable house payment is to consider the 30% rule. This is a guideline that advises you to keep your total housing expenses under 30% of your income, which means your mortgage payment and any other housing-related taxes or fees all added together should cost 30% or less of your income each month.
Let’s say your monthly income is $5,000. In this scenario, 30% of your income is $1,500. That means your monthly mortgage payment, homeowners insurance, property taxes, HOA fees and any other housing costs combined shouldn’t exceed $1,500.
This leaves your other 70% free for savings, loan payments, childcare costs, groceries and other living expenses. Your lender may use this rule when qualifying you for a home. If you anticipate that your housing expenses will exceed this ratio, you may want to take some time to address other factors, such as your credit score, which can play a role in the interest rate you get (and thus help lower your housing expenses each month once you have a mortgage).
Keep your own personal goals in mind. Think about how you want to live and how you spend your money. If you have big travel plans or are spending a lot on education, you may eventually want to narrow your search to properties with payments that cost much less than 30% of your income.
Your Debt-to-Income Ratio Matters
Your debt-to-income ratio is all of your debts added up and divided by your gross — not net — income amount. Think of it as the percentage of debt that takes up the total income you earn.
As an example, say that your rent is $1,200, your car payment is $300 and your remaining debts are $300, for a total of $1,800 every month. Your monthly income totals $5,500. If you divide your debt total by your income total, you get 0.327, which is a ratio of about 33% when rounded up.
It’s important to determine this amount because many lenders look at this equation during the process of approving you for a mortgage. They want to make sure you have enough income to support your debt payments as well as your new mortgage payments.
It’s ideal to have as low a debt-to-income ratio as possible. The lower your ratio, the more favorable your loan terms, such as your interest rate, will be because you’ll represent less of a risk to the lender. Borrowers who have excess debt are statistically more likely to default on their home loans, and this isn’t the impression you want to create with potential lenders.
When you’re making your budget, account for debt repayments. Again, you may want to spend some time focusing on paying down outstanding debts before you begin the mortgage-application process. Set up automatic payments through your bank account to stay on top of what you owe, and consider freezing your credit cards so you don’t accumulate more debt while you’re working towards a new home.
It’s Essential to Understand Your Credit Score
Your credit score plays a big role in how much of a mortgage payment you can afford. If your credit score is low, your lender will typically extend you a higher interest rate because you’ll be perceived as a riskier person to lend to. This means your monthly loan payment will be higher.
Think of this as a cycle of debt. The more debt you have, the lower your credit score becomes and the more you’ll pay for your mortgage. This means you’ll qualify for less and you’ll pay more in interest each month.
Before you apply for a mortgage, get free copies of your credit reports and take a look at what shows up on them. This gives you the opportunity to work on problem areas and dispute any errors that may be lowering your credit score unnecessarily. If you take some time to raise your score, you can save money on your mortgage payments.
Your Down Payment Factors In, Too
Your down payment also plays a role in how affordable your mortgage payments could be. The more you can afford to put towards a down payment, the lower your monthly payments will be because you paid for more of the home’s cost up front. Before you apply for a mortgage, look at how much you can put down.
Making at least a 20% down payment means you won’t have to pay for private mortgage insurance. In some cases, however, you may opt for a lower down payment in order to keep more money in your savings account for emergencies or home renovations. Just remember, though, that your down payment lowers your loan amount and gives you more equity in your home right off the bat. So, it’s worth your while to take time to save up as much as possible for your down payment ahead of time, even if it means postponing your home search a bit longer.
A Preapproval Helps Give You the Full Picture
Your lender may preapprove you for a mortgage during the application process. This can give you an idea of how much you qualify for and the maximum amount that your monthly payments could be. During the preapproval process, your lender will verify your employment and your income. They’ll also run a credit check and assess your debts.
Once they take these factors into consideration, they’ll come up with your loan terms and interest rate. The better your credit and financial situation are, the better your terms will be. This means you’ll save more money on your payments each month. Getting preapproved helps you come up with a mortgage payment that works for your lifestyle and your budget.