Three Ways to Answer the Question: “How Much House Can I Afford?”
In most cases, by the time you reach my office to begin the search for the home of your dreams, you already have a good idea of how much house you can afford. So I don’t get that question all that often. Trouble is, one measure of housing affordability might not be the same as another. SoI thought I’d take a moment to discuss the various answers you might receive to the question: “How much house can I afford?”
With few exceptions, people who are selling their home are often buyers of another home. First time home buyers, those new to the experience will need to understand how a miscalculation when asking this question can create problems further down the road. While online mortgage calculators do a great job at estimating many of the costs, the reality can be quite different.
How much house can I afford, the Lender’s version
Lenders don’t take your hopes and dreams into consideration, whether you have already begun looking at properties or even if you’ve just been inputting numbers into a calculator. They care only about the numbers and more specifically, one number: your total debt obligation.
Often referred to as DTI, or debt-to- income ratio, this number reflects how your current debt, added to your future debt (in the form of a mortgage payment, interest, taxes and insurance) impacts your ability to enter into a long-term lending agreement like a mortgage. It varies from lender to lender, but when expressed as a percentage, it shows in graphic detail how much debt you can reasonably handle. The ceiling can be as a high as 45% in conventional lending with excellent credit scores and up to 40% in jumbo mortgages. If you are beginning your search, you will need to bring as little debt as possible to the table.
The front end version
Because lenders are focused on “could” rather than the “should,” they tend to use two different calculations to determine how much house you can afford. The first calculation is called the front end ratio. In this calculation, the lender will put a 28% ceiling on these four totals, regardless of your other debt obligations.
Monthly principal + interest payments – may fluctuate over time based on rates
Monthly real estate taxes due –estimated at the current levels
Monthly homeowners insurance due – also estimated and based on potential approval
Monthly dues to an HOA (Home Owners Association) – may or may not apply to your situation
Back end version
This is more reality based and uses your personal accounting of your debts with the addition of your mortgage. This percentage, once calculated cannot exceed 38% of your total household income. (The number I mentioned earlier, the 45% and the 40% can be considered napkin calculations.) Once that calculation is done, the back-end ratio is calculated to determine just how much house you “could” afford if everything stays the same and no additional debt is assumed.
Monthly housing payment(s) – includes the front end ratio
Monthly minimum credit card payments – but will consider balances and debt utilization
(the amount of credit you have access to at any one time).
Monthly child support or alimony
Monthly car payments for a car loan or lease – including any co-signatures
Monthly payments to an installment loan
With those raw numbers in hand, you will need to ask yourself the question the lender sort of answered. Regardless of what they approved you for, you should have some sort of handle on the reality of your personal finances. If your household income is not as stable as the lender assumes, if you know of something that could upset your financial standing in the near future, or you have not yet made a budget, you will need to be honest with yourself. None of these calculations reflect the reality of actually owning a home. The cost of upkeep and improvements can only be estimated but prudent borrowers should make some estimates of these costs in advance.
So the question probably shouldn’t be “How much house can I afford?” Instead, it should be “How much debt can I assume without derailing my future?” There is a house out there for you and we are here to help you find it.
How can we assist you today?
On behalf of The Jones Group @ Sunriver Realty
Nola Horton-Jones, Principal Broker/Realtor | ABR, C-RIS, e-PRO, GREEN, RSPS, CCIM Candidate
Bryce Jones, Broker/Realtor | ABR, CRS, e-PRO, GREEN, GRI, RSPS, SFR
Karen Marcy, Broker/Realtor
The Jones Group @ Sunriver Realty | 57057 Beaver Drive | Sunriver, OR 97707
Mobile: 541-420- 3725 | Mobile: 541-420- 4018 | Mobile: 503-327- 9611 | Fax: 541-593- 5123
Licensed in Oregon