Can You Afford a Home?: Do the Math

We’ve been talking this week about preparing to buy a home, even if you have some negative financial experiences in your past. You can start cleaning up your credit by getting a free report, consolidating your debts, and cultivating good spending habits. Even if you’ve experienced bankruptcy, you can still buy a home with good income, enough cash for the down payment, and good credit history since the bankruptcy.

What if you have fine credit, a clean financial record, but are still wondering if you can really afford to buy a home? A lot of people, especially first-time buyers, fall into this camp. You can’t predict the future, but you can run your finances through a home affordability calculator to determine whether you can safely afford investing in a home.


Run the numbers

The math isn’t foolproof, and life can quickly and dramatically change your financial situation, but here are some good figures to think about:

Debt-to-income (DTI) ratio is the percentage of your monthly gross income that goes toward paying off your home and your other debts. A typical DTI required by a lender is 28/36.

The first number represents the front-end ratio. The front-end ratio is the percentage of your monthly income that can be used to pay your mortgage, property taxes, and any other homeowner’s expenses.

The second number represents the back-end ratio. The back end ratio is the percentage of your monthly income that can be used to pay down all your debts, including paying off your mortgage.


Play out the scenario

Say you make $5000 every month. The lender will approve your home loan if and only if your monthly mortgage payment does not exceed $1400. You’re considering a home where the total monthly housing expenses would come out to $1200 – you’re safe, right?

Well, not so fast. Say you’re paying off some graduate school loans. Your interest rate isn’t great, and your monthly payments are $450. If this is the only other debt you have, your total monthly debt payments will come out to $1650. So is your back-end ratio low enough?

Multiply your monthly income of $5000 by 36%, and your max back-end payment would come out to $1800, so your lender will likely approve you for this loan and you can afford it as long as your financial situation doesn’t drastically change.


Figure out the down payment

Another big figure to consider is the down payment. For many first-timers, this can be the hardest sum to come by. Most lenders are going to want 20 percent of the purchase price paid as they down payment, though there are definitely options to pay 10, 5, or lower depending on your situation.

Figure out how you’re going to save up these funds, but don’t focus on just buying the home. That mortgage bill will arrive every month, and you don’t want to have cut it too close and sacrifice your well-being (and possibly your health) just to keep your home.


Seek advice

Talk to your agent, a financial advisor, and others who have already bought homes about their experiences. Think about the long-run, and make sure that before you rush to buy, you’ve run the number carefully so you feel confident about how much home you can reasonably afford.


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Sarah Louise Green lives in the San Francisco Bay Area and writes about national real estate trends, home financing, advice for buyers, and DIY projects for the home and garden.


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