When you're ready to build a nest with the one you love, the logical first step is figuring out how much you can afford. To do so, you may apply a formula many lenders use. It involves calculating 28 percent of your income, which is a generally accepted maximum for a mortgage and related housing expenses. Alternatively, you can use a commonly applied debt-to-income ratio to figure out how much dream home you and your better half can afford.
Figure out your gross annual income. This is your total income before taxes are taken out. Add your other half's income to this.
Add any unearned income to your combined gross annual income total. For example, if you receive income from investments, alimony or even lottery winnings, add these amounts to your annual gross income.
Multiply your annual gross income total, including the sums added in for unearned income sources, by .28. This will give you 28 percent of your annual income. This is the maximum amount you can spend on your mortgage in a year. Many lenders prefer to grant mortgages that do not exceed 28 percent of the borrower's annual gross income.
Divide 28 percent of your annual gross income by 12. This is the maximum amount most traditional lenders will expect you to spend on your mortgage on a monthly basis.
Use a Debt-to-Income Calculation
Add up all of your monthly debts, included mortgage payments, mortgage-related expenses like taxes and insurance, car loans, student loan debts and credit card bills. Divide any debts you pay annually by 12 to include them in your monthly debt calculation.
Calculate 36 percent of your monthly income. Start out with your gross monthly income and multiply it by .36. The result will be 36 percent of your monthly income.
Compare your monthly debts, including your mortgage, to 36 percent of your gross income. If the total for your monthly debts is higher than 36 percent of your income, you may need to seek a lower mortgage payment or find ways to eliminate some of your other debts. Traditional lenders are less likely to grant a loan that results in a debt-to-income ratio that exceeds 36 percent of your income.
- Mortgage-to-income and debt-to-income ratios are just guidelines to follow in figuring out how much home you can afford. The amount of mortgage you will qualify for depends on the unique loan criteria your lender sets.
- When considering how much mortgage you can afford, think about how you would afford your mortgage if you or your spouse were unemployed for a significant period of time. You may avoid foreclosure by opting for a mortgage you could afford with only one household income.
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