Slate tiles, marble countertops and thousands of square feet sound good to most of us. For others, it’s acres of land, multiple outbuildings and a view of the mountains. It’s time to get realistic and measure our dreams against our realities. Unless you have a rock star’s bank account, the house of your dreams may be out of your price range. Here are five methods for figuring out how much house you can buy without having to beg, borrow and steal for your mortgage payment each month:
1.Multiply Your Income
Multiplying your yearly gross income by 2.5 or 3 was the general rule of thumb for years. Though it still works, you need to keep in mind that it’s only a very basic tool. To figure your affordable home price using this method, take your yearly gross income and simply multiply it by no more than three. For example, if you have a gross income of $50,000 per year, you should look for a home that costs no more than $150,000. Keep in mind, however, that your credit score and current interest rates can factor heavily into this method.
2.Dave Ramsey Method
Dave Ramsey is a financial author, motivational speaker and radio host and considered by many to be a financial expert. To properly use this method, you need to have at least a 20 percent down payment and your house should cost you no more than 25 percent of your take home pay. Figure out how much you have saved for a down payment and multiply that amount by .20. For example, if you’ve saved $25,000, your maximum home purchase price would be $125,000. If you follow Dave’s advice and finance your remaining $100,000 on a 15-year mortgage, your house payment would be approximately $1,000.
This rule is also known as the back-end ratio. What banks look at, beyond your income, is your debt load. Your debt includes your projected mortgage payment, house insurance, property insurance, any loans that you currently hold and your credit card debt. When added together, your outgoing payments should not total more than 36 percent of your gross income. For example, if you make $60,000 a year, your debt payments should not total more than $1,800 per month.
This method has absolutely nothing to do with your current debt and everything to do with your income. When banks are evaluating your loan application, they look at your monthly income and projected mortgage payments. Banks assume that you are a safe bet if your projected payments total no more than 28 percent of your monthly income. For example, if you bring in $5,000 per month, your mortgage payments should not exceed $1,400. If you only make $2,000 per month, your mortgage payments should not exceed $560.
FHA loans are popular among first-time home buyers because they are typically less restrictive and easier to qualify for. When it comes to the back-end ratio, the maximum percent is raised to 41 percent. For mortgage expense-to-income, your maximum percentage is 29. Though these loans are sponsored by the government, you can secure them through mortgage companies and private banks.
Buying the house that you can afford instead of the home you dream of can help to ensure that you aren’t a victim of foreclosure. Keep in mind that you can always turn your affordable home into your dream home with slow changes. Even if you are offered a higher loan than you expected, don’t get sucked in by the banks. At the end of the day, you are the one that has to make your monthly mortgage payment, not your loan officer.
About the Author: Robin Knight blogs on how to afford your dream home in Virginia. The homes in Alexandria are beautiful and great investments.