The three basic ways to make a rough estimation of how much you can spend on buying a new home are:
- Pick a total payment which is close or equal to what you are currently paying for rent
- Set the maximum price of the house to three times the annual income of the family members
- Pick a payment which is not bigger than 1/3 of your before-tax income
Of course, these simple methods of determining the price you can pay for a home are very rough, so if you want a more precise answer to this important question you can use this useful and accurate online mortgage calculator ( www.mortgagecalculatorplus.com ).
While the rough estimates are relatively easy to determine, there are some guidelines which will help you more realistic calculations to see what is affordable and what is not.
Here is how to make more precise estimates on how much you can spend on buying a home right now.
Look at your DTI (debt-to-income ratio)
This is used by lenders to determine how much you can afford. It compares all the recurring monthly debt payments you have with your gross income for the month. If you have a monthly income of $6,000 and you plan on spending $2,000 for your monthly house payments as well as for all other ongoing debts, this means that your DTI is 33%.
Front-end ratio and back-end ratio estimates
The front-end ratio compares the housing costs with your gross monthly income before tax. In other words, the front-end ratio equals the future housing cost divided by the monthly income before tax.
The housing costs include the mortgage principal and interest as well as property taxes and insurance and any HOA dues.
The back-end ratio is calculated by adding the future housing costs to the other ongoing debt payments such as student debts, credit card payments, car loans, and others.
As a whole, your ratio will be better if you have a higher income and lower ongoing monthly debt payments.
Many lenders use the 31/43 ratios, which means that 31% of your monthly income can be for the house payments and a total of 43% can go for the house and your other monthly debt payments.
If your gross monthly income is $6,000, 435 of that is about $2,600 which is the maximum you can spend for paying for the house as well as making your other debt payments.
Given that according to this example the housing cost is $1,600, the remaining $1,000 is for all other debts including student loans, cars, credit cards and others.
In conclusion, it is crucial that you carefully look into your monthly debt payments and figure out ways to reduce them or if possible eliminate them before you start looking for a house to buy.