Mortgages are a great way to finance your new home if you don’t have enough capital to pay in full, which is the case for the large majority of the US population. But when you apply for a mortgage, it’s best to determine how much money you can borrow before you go and start looking for home that you may not be able to afford. When you go about the housing market with a rough idea of your budget and what type of mortgage you can afford, it will be much easier to narrow down your options and pick your next home.
Your Debt to Income Ratio
One of the main factors that go into how much mortgage buyers can borrow is their debt to income ratio. Also known as DTI, this is a measurement that lenders use to determine and ensure that you’ll be able to cover all the loan costs moving forward.
When measuring DTI, lenders consider all existing debt and the new debt that comes along with the mortgage. In the large majority of cases, the lender will consider your student loans, car loans, and other payments before adding in the mortgage costs.
From there, lenders will easily see how much you can afford in monthly payments.
DTI ratio is calculated by dividing your total monthly debt by your income. So, for example, if you earn $8000 per month and have a monthly debt of $800 per month, your DTI ratio will be 10%. When you have a low DTI ratio, you will generally be approved for higher mortgages and monthly payments.
While specific government programs don’t require a downpayment before getting a loan, such as the Veteran Affairs loan and others, most mortgages will require a downpayment beforehand.
The cost of the downpayment? It depends on the type of loan you’re applying for. If you apply for a Federal Housing Administration loan, the downpayment is around 3.5% of the sales price, but it can go as high as 20% of the sales price with other loans and programs.
Typically, buyers pay between 2%-5% of the total sales cost for housing loans. Keep in mind that this doesn’t include closing fees, which are required when purchasing a home. The higher your downpayment, the more likely you are to get favorable interest rates.
For example, if you pay a 20% downpayment, you get a much lower interest rate than if you were to pay a 5% downpayment.
Credit scores are based on one’s payment history, types of credit you have, new credit applications, and how long you’ve had credit. This is one of the most important factors lenders consider when determining how much mortgage one can borrow.
When lenders check your credit report, they pay close attention to your credit score. If you have a low credit score, you may still apply for a loan but expect higher fees and overall higher mortgage payments. If you have a high credit score, it will be much easier to secure a loan with lower monthly fees.
Before you apply for a mortgage, we highly recommend checking out your credit profile first. And if you find you have a low credit score, it’s best to take measures to increase it.
You can increase your credit score by paying off your debts, paying your bills on time, or you can make a significant payment on existing debts. All of these things can improve your credit score and allow you to secure a more desirable mortgage.
Keep in mind that lenders don’t look at all these factors in a vacuum. While they focus on specific factors when determining the loan you can afford, they will always look at the bigger picture and consider all of these things.
Experts like Breezeful recommend that first-time homebuyers have no existing debt, have a good credit score, and have 3-6 months’ worth of expenses saved up in their bank account before applying for a mortgage. This can help you secure much better rates and even qualify you for higher loans so you can get the home of your dreams.