How Much Can You Afford?
Start out with a budget so you can determine your price range
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If you're like many first-time homebuyers, chances are you've been spending your weekends driving around visiting open houses and new model homes. This is a great way to get a feel for what you want. The problem is that what you want isn't always what you should get.
Before you start touring homes for sale, it's important to start off with a budget so you know how much you can afford to spend. Knowing what mortgage payment you can handle will also help you narrow the field so you don't waste precious time touring homes that are out of your reach.
Where to begin
The key factor in figuring how much home you can afford is your debt-to-income ratio. This is the figure lenders use to determine how much mortgage debt you can handle, and thus the maximum loan amount you will be offered. The ratio is based on how much personal debt you are carrying in relation to how much you earn, and it's expressed as a percentage.
The ideal ratio
Mortgage lenders generally use a ratio of 36 percent as the guideline for how high your debt-to-income ratio should be. A ratio above 36 percent is seen as risky, and the lender will likely either deny the loan or charge a higher interest rate. Another good guideline is that no more than 28 percent of your gross monthly income goes to housing expenses.
Doing the math
First, figure out how much total debt you (and your spouse, if applicable) can carry with a 36 percent ratio. To do this, multiply your monthly gross income (your total income before taxes and other expenses such as health care) by .36. For example, if your gross income is $6,500:
$6,500 (Gross monthly income)
x .36 (Debt-to-income ratio)
= $2,340 (Total allowable monthly debt payments)
Next, add up all your family's fixed monthly debt expenses, such as car payments, your minimum credit card payments, student loans and any other regular debt payments. (Include monthly child support, but not bills such as groceries or utilities.)
Minimum monthly credit card payments*: ____________
+ Monthly car loan payments: ____________
+ Other monthly debt payments: ____________
= Total monthly debt payments: ____________
*Your minimum credit card payment is not your total balance every month. It is your required minimum payment -- usually between two and three percent of the outstanding balance.
To continue with the above example, let's assume your total monthly debt payments come to $750. You would then subtract $750 from your total allowable monthly debt payments to calculate your maximum monthly mortgage payment:
$2,340 (Total allowable monthly debt payments)
- $750 (Total monthly debt payments other than mortgage)
= $1,590 (Maximum mortgage payment)
In this example, the most you could afford for a home would be $1,590 per month. And keep in mind that this number includes private mortgage insurance, homeowner's insurance and property taxes. To determine the price of home you can afford based on this amount, use a home affordability calculator.
Exceptions to the 36 percent rule
In regions with higher home prices, it may be hard to stay within the 36 percent guideline. There are lenders that allow a debt-to-income ratio as high as 45 percent. In addition, some mortgage programs, such as Federal Housing Authority mortgages and Veterans Administration mortgages, allow a ratio higher than 36 percent. But keep in mind that a higher ratio may increase your interest rate, so you may be better off in the long run with a less expensive home. It's also important to try to pay down as much debt as possible before you begin looking for a mortgage, as that can help lower your debt-to-income ratio
SO BASICALLY...from this example...she is trying to buy TOO MUCH HOUSE
I would personally recommend 1. Coming up with minimum 10% down (that way if she does have financial difficulty there is 20K in equity to make sure she doesnt forclose and can sell. or
2. look for a house around 160K in total. MAXIMUM
Most people could fit a nice size mortgage payment in there budget, but they are trying to jump the gun alittle.....In other words keep in mind that this 200K home, although very nice, it doesnt have to be the very next house she buys.....U could always buy a 140-160K house and then save 200-300 a month for 5 years and have another 10-20K plus the equity in that house from sale to buy the 200-225K home and have a mortgage of 180-200K to start and get more house for the money.
Most people are trigger happy and buy on impulse...Im sure a nice 140-160K house would do her just right....Personally it sounds like she doesnt have any money saved up, so why would she want to be strapped to a mortgage payment that is overwelming and to the limit when she has no personal savings (besides work 401K etc).
Hopefully u can expain this to her...I have worked with thousands of clients who have cried tears in this foreclosure world, and u explaining this to ur sister could save her a bundle of stress/heartache/ and money in the long run.
Goodluck
-murph