Although your DTI and housing expense ratios are important factors in mortgage qualification, other variables impact your monthly mortgage payment and how much you can afford. Next up are several factors that can help you figure out the right price range before you hit the pavement looking for a new home. Mortgage term refers to the length of time you have to pay back the amount you’ve borrowed. The most common loan terms are 15 and 30 years, but other terms are available. Your mortgage term impacts your monthly payments. The longer the loan term, the smaller your monthly payments will likely be. Here’s an example: If you get a $200,000 mortgage with a 15 year fixed rate at 5%, your monthly payments will be $1,582 (excluding taxes and insurance).Mortgage Term
Now, let’s change the term. Let’s say you still take out the $200,000 loan with a 5% interest rate, but the term is 30 years. Your monthly payments will now be $1,074 (excluding taxes and insurance).
Once you close on your home loan, your monthly mortgage payment may well be the biggest debt payment you make each month, so it’s important to make sure you can afford it. Your monthly payment and down payment are probably the two biggest factors in determining how much you can afford.
Mortgage Interest Rate
Mortgage rate refers to the interest rate on your mortgage. Mortgage rates are influenced by market interest rates but ultimately determined by your lender and can be fixed or adjustable. This means they can stay the same or change over the life of the loan. Your rate can be higher or lower depending on your credit score, down payment and other factors.
Suppose you bought the same $200,000 house as above with the 15-year fixed mortgage at 5% but the mortgage interest rate changed to 6.25%. Your payment would go up, from $1,582 to $1,715 per month.
Even a small difference in interest rate could mean a difference of hundreds or even thousands of dollars in interest you’ll pay over the life of the loan. Interest rates also affect the size of your monthly payment, which has the most direct impact on affordability.
Your Monthly Budget
Now that you’ve looked at your DTI and any debt you may have, think about your budget. How does a monthly mortgage payment fit in? If you don’t have a budget, keep track of your income and expenses for a couple of months. You can create a personal budget spreadsheet or use any number of budgeting apps or online budgeting tools when allocating your annual income.
In the mortgage process, it’s important to look at your budget, savings and assets for a couple of reasons. For one, you might need savings for a down payment.
Reserves
Reserves refer to the number of monthly mortgage payments you could make from your savings if you lost your job or experienced another event that impacted your ability to make your payment. Every loan program is different, but a good guideline is to keep at least 2 months’ worth of mortgage payments in your savings account.
Look at your full financial picture after you’ve tracked your income and expenses for a few months. For example, if you realize you have $3,000 left over at the end of each month, decide how much of that could be allocated toward a mortgage.
Alternatively, you could buy a more affordable house. Take some of your extra money and put it toward your mortgage principal every month to pay off the loan faster.
Down Payment
You might think you need to plunk down 20% of your purchase price for a down payment, but that’s actually not true. You can get a conventional loan (a loan not backed by a government agency) for as little as 3% down.
That’s not to say a higher down payment lacks advantages. For example, you may see the following benefits by increasing the amount you put down on your home:
- A lower interest rate: Your interest rate is largely shaped by your down payment and median FICO® Score. The higher your down payment, the better your interest rate will be. If a lender doesn’t have to loan as much money, the investment is considered lower risk.
- No mortgage insurance: If you put down less than 20% on a conventional loan, you’ll have to pay for private mortgage insurance, which will technically be tacked onto but included as part of your monthly mortgage payment. Mortgage insurance protects your lender and the mortgage investor if you don’t make payments and default on your loan, but this insurance can significantly increase how much you’ll spend each month on your mortgage.
As you determine how much house you can afford, remember to factor in down payments, especially if you’re trying to afford the 20% to avoid PMI. Note that you might not have to put down anything at all if you qualify for certain government loans.
Extra Costs
In addition to the cost of your down payment and any mortgage insurance, you’ll need to consider homeowners insurance, property taxes and closing costs:
- Homeowners insurance: Your homeowners insurance amount depends on where you live, your neighborhood and the type of home you buy. Homeowners insurance calculations also consider the value of your property, potential rebuild costs and the value of your at-risk assets. It’s best to call an insurance agent to get an idea of what your homeowners insurance amount could be.
- Property taxes: If you own property, you pay property taxes, which amount to your property’s assessed value multiplied by the local tax rate. You can ask your local tax assessor for more information.
- Closing costs: Typically, you must pay closing costs on your closing day – the last step in the home-buying process. Your lender will give you an estimate of your closing costs. These include the loan origination fee, appraisal fees, title search fees, credit report charges and more. Closing costs on a home purchase are often 2% – 6% of the loan amount.
