Your house will likely be the most significant personal investment you make. This means assessing how much you can afford is crucial. How much you can afford depends on many factors. Generally, you want to avoid narrowing down your factors to just what a bank is willing to offer you. You need to assess your finances, preferences, and other priorities.
With a salary of 40k, it means you can afford a mortgage that is 2x to 3x your gross income. Additionally, you’ll need to have a certain level of surety in understanding your monthly mortgage payments. While your income and regular monthly expenses may be moderately stable, emergency expenses can affect your savings. This guide covers what you need to consider before taking a mortgage to understand the mortgage process.
Calculating The Costs
As mentioned above, buying a home is the biggest purchase you’ll make in your lifetime. Start by setting a budget upfront. This needs to happen before you start looking at homes: Most homebuyers fall into the trap of loving a home they can’t afford. This is where a simple mortgage calculator comes in handy. Your mortgage payment includes four elements. Together, these form what banks terms as PITI and have principal, interest, taxes, and insurance. Your loan calculator will help you factor in PITI fees.
The Dilemma: What Home Best Suits You?
You have multiple options when buying a home. From a condo to a single-family house to a multi-family building with several units – the options are limitless! Every choice you pick has its pros and cons and depends on your homeownership goals. Ultimately, this will come down to personal preference. You’ll need to choose a home to help you reach your goals. You can lower your purchase price by choosing a fixer-upper. However, you’ll need to put in time and money to turn a fixer-upper into a dream home.
What’s Your Debt-to-Income Ratio (DTI)?
The DTI ratio is a critical metric your bank uses to evaluate the amount of money you can borrow. The bank will compare your overall monthly debts to your monthly pre-tax income. They will also check your credit score. If the score is good, you may be qualified at a higher ratio. In most cases, housing expenses shouldn’t exceed 28% of your monthly income. For instance, if your monthly mortgage payment (insurance and taxes included) is 1,200 a month, and you have a monthly income of 4,200 before taxes, your DTI is 28.57%. (1200/4200 = 0.2857).
Front-End Ratio (FER)
This is where your gross income helps determine the FER ratio, also known as the mortgage-to-income ratio. So, how is this ratio determined? Generally, this is the percentage of your yearly gross income that’s dedicated to offsetting your mortgage each month. As mentioned earlier, PITI makes up the overall amount of money that makes up your monthly mortgage payment. To play it safe, ensure your PITI doesn’t exceed 28 percent of your gross income, as mentioned above. However, some lenders allow borrowers to exceed 30%, others even 40%.
As a general rule, get your credit in order before applying for a mortgage. You can visit a credit bureau near you to check for a credit score. Most bureaus offer one free copy per year of your credit report. Once you get your account, please review it carefully. Check for any incorrect figures and negative factors. If there are errors on the credit report, ensure you alert the reporting agency immediately. You might have to prove that claims are wrong by providing sufficient documents such as your payment history. If it’s an issue with identity fraud, ensure you file a report with your police department.
A more significant down payment equals better mortgage rates. Why is this so? Typically, a lender is taking a lesser risk by offering you less money and ensuring you have more equity in the home. The LTV (loan-to-value) ratio factors in your down payment. The higher the down payment, the lower the LTV and the lesser risk the lender assumes. If you’ve not saved much for a down payment but are ready to buy, you can refinance into a reduced rate loan later. You only need to ensure the provided market conditions are favourable.
There’s a lot that goes into deciding a mortgage, but the above tips are fundamental. Remember: a mortgage is the most significant personal expense you’ll ever take. Before you accrue such an immense debt, do your homework carefully. Go through the figures with a financial analyst or your accountant. Finally, consider your financial situation and lifestyle factor – not just currently but into the next 10 or 20 years.