Purchasing a home is likely the most significant expenditure you’ll make in your lifetime. However, before beginning the hunt for your dream house, you’ll need to determine how much you can afford. Mortgage underwriters look at various factors to pre-qualify you for a mortgage, including your gross income, down payment amount, and credit score.
Our software offers excellent tools that enable you to calculate your debt-to-income ratio and cash position – two critical factors used by underwriters.
Before you start placing offers, consider the below factors to help you understand what affects your mortgage pre-qualification amount.
Your Gross Income
Gross income is a significant factor in determining a mortgage loan amount. An underwriter will look at your salary, bonuses, 1099 income, and government payments, including social security and disability. Most lenders will verify two years of income. If you just started working full-time, you might not qualify for a mortgage yet.
Financial experts suggest spending no more than 28% of your gross income on living expenses. Therefore, a common rule is keeping your mortgage amount between 2 – 2.5x your annual gross income. Nevertheless, lenders still consider other factors, such as your credit score.
It’s no surprise that those with lower credit scores will pay higher interest rates. If you have a credit score below 520, it may be challenging even to secure a mortgage. Many people in the market to buy a home try to clean up their credit reports before applying for a mortgage.
A poor credit score will typically lower the amount of house you can afford. The reason for the reduced mortgage is because you’ll pay more interest on top of repaying the principal, resulting in a higher monthly payment. If the lender allows you to buy more house, you could overextend your finances.
Mortgage underwriters consider HOA fees when calculating your pre-approval amount. HOA fees and how much house you can afford have an indirect relationship. Higher HOA fees will result in a lower mortgage amount. Lenders may also look at special assessments – one-time fees that homeowners must pay for large-scale property maintenance and repairs. An assessment would likely cause a lender to lower the amount they’re willing to lend.
When interest rates are low, you can generally afford more house because you’ll have a lower monthly payment. However, interest rates depend on various factors – your overall creditworthiness, the current federal funds rate, and supply and demand for loans.
There is one caveat to consider – the down payment amount. For example, if you need to put 20% down to maintain a favorable interest rate, you must stay within budget.
Property tax rates drastically vary across the United States – often levied by local municipalities. To illustrate, Hawaii has an annual property tax rate of 0.28% – the lowest in the nation. New Jersey, on the other hand, has the highest at 2.49%.
When shopping for a home, it’s always vital to include the property tax in your projected monthly payment. You should also consider how the property tax rate and property values have changed over time.
Lenders won’t give you a mortgage if you’re already carrying a heavy load of debt. Mortgage underwriters look at your debt-to-income ratio – your total amount of debt divided by your income. The general rule of thumb is that you should have a debt-to-income ratio no greater than 36%.
If your debt-to-income is too high (i.e., greater than 43%), you’ll have to opt for a non-qualified mortgage. In short, this is a risky loan that doesn’t adhere to the Dodd-Frank Act – an act passed after the 2008 financial crisis. Lenders who offer non-qualified mortgages may require more money down and charge a higher interest rate, which will ultimately lower how much house you can afford.
Your Down Payment
Generally, you can afford a more expensive house if you have a solid cash position and make a sizeable down payment. Many lenders require that you put 20% down to avoid private mortgage insurance (PMI). If you don’t have enough to make a 20% down payment, you’ll have to pay .5 – 1% of your mortgage annually for PMI. If you have a $300,000 mortgage, you could have to pay $3,000 annually ($250 per month).
As you can see, PMI increases your monthly payment and consequently reduces the amount of house that you can afford. Moreover, the ability to put 20% down will increase your chances of approval and help you secure a lower interest rate.
We understand that househunting is a stressful yet exciting journey. Our tools – including the ability to view your total income and debt – can be of tremendous help when you start looking for a home.