Step 3: How Much Can I Afford?

How much how you can afford depends on how much money you can pay upfront plus how much you can pay monthly.

Put simply:

down payment    +    mortgage you can get    =    most expensive home you can afford

Most families can afford a home worth up to three times their annual household income, if they can make a substantial down payment and have only a moderate amount of other debt. If you have little to no debt and can put 20% down you can probably afford a house worth up to four times your annual income.

The bigger down payment you can offer, the bigger the mortgage you can get. About your down payment.

The more debt you already have, the smaller the mortgage you will get. About your debt ratio.

The better you are at managing your debt, the bigger the mortgage you can get. About your credit rating.

The longer your loan period is (30-year vs. 15-year), the lower your monthly payments will be.(But you’ll also end up paying more money over the life of the loan.)

Here’s a calculator for estimating how much home you can afford. Also, here's a worksheet to help you figure out how much money you need to bring to closing.

About down payments

A down payment is partial payment made at the time of purchase.Most buyers take out a loan (“mortgage”) for the balance, and make monthly payments until the loan is paid off.A mortgage payment includes a partial payment of the cost of the home (“principal”) plus an interest charge calculated based on how much is still owed.

It is possible to get a mortgage with a 0% down payment if you have an outstanding credit score (700+), but the higher a down payment you can pay, the more doors will open for you.Higher down payments send a signal to lenders that you will have the ability to make your monthly mortgage payments. Aim for 20% of the purchase price.

Long-term benefits of making a higher down payment

• Own more of your home
• Easier to find a mortgage lender
• Easier to qualify for a mortgage
• Lower monthly mortgage payments
• Less likely to be required to pay for private mortgage insurance
• Less likely to lose home to foreclosure

Make a lower down payment now or a higher down payment later?

The primary benefit of owning versus renting is the ability to lock in a monthly payment for 15-30 years and then stop paying altogether. The sooner you can get into a new home, the sooner you can kiss rising rent payments goodbye.

But if you don’t have a lot of money put aside for a down payment, should you put off buying until you’ve saved up more?The answer depends on:

• Your credit score
• How much house you want
• Market conditions and trends, such as:
  – Mortgage rates
  – Tax incentives
  – How many houses are for sale
  – How quickly houses are selling
  – Time of year
• What kind of a mortgage you can get with what you have

One reason to get yourself a good buyer’s agent like Robin Guernsey is that she has worked with every sort of buyer in every sort of situation and can give you good advice, based on her knowledge of the market and your own hopes and dreams.She can also refer you to a reputable lender who can help you weigh your options to make the decision that’s right for you.

Pay down debt or save for down payment?

Before giving you a mortgage a lender will want to know you can make your monthly payments.Lenders look at your credit report, which shows how good you are at paying your bills on time.

They also look at how much of your pre-tax income you are currently using to make minimum payments on credit cards, school loans, auto loans, etc.This is your debt ratio:

monthly minimum payments    ÷    monthly pre-tax income    =    debt ratio

The debt ratio tells your lender how much money you’ll have available to make your monthly mortgage payments after you’ve paid your other bills.Aim for a debt ratio of below 20% in order to qualify for a good mortgage rate.

The better your credit score and the more money you can put into your down payment, the less your debt ratio will matter to lenders.

Buyer’s agent Robin Guernsey can give you good, objective advice how much down payment you’ll need to reach your goals.

• Above 38% -- You will probably not qualify for a mortgage until you pay down more of your debt.Start with your higher interest credit cards.
• 20% - 37% -- Do what you can to pay down debts, beginning with your higher interest credit cards.
• 19% and below -- Save up for that 20% down payment. It will get you a better interest rate, make it easier to qualify for a loan, and result in smaller monthly mortgage payments.