You are ready to start seeking out your dream home, what is the first step? As a mortgage advisor, I highly recommend getting pre-approved ahead of time- you might be surprised by what you can afford! Outside of this, there are two ways to go about planning this exciting new venture.
You can look at your salary and estimate how much house you can afford based on what you earn every month.
You can take a look at the type of house you’re dreaming of and estimate how much income you’ll need to be able to afford it.
Whatever route you take this article will help you determine just how much money you’ll need to put aside to make your monthly mortgage payments.
Mortgage Payments 101
It’s important that you understand what a mortgage payment covers before you dive headfirst into buying a home. Typically purchasing a home requires a down payment of 20%, but this is not always the case! If you don’t have 20% saved up, reach out to your mortgage advisor, they can help!! Depending on what you qualify for, you will be loaned for the remainder of the purchase price to pay the seller.
As the homebuyer, you agree to pay back the money loaned to you with interest- typically in a monthly payment. Be sure to talk to your mortgage advisor about the ins and outs of the loan so that you are aware of all that you are paying for. Some loan payments can include insurance and property taxes all rolled into one. A typical loan repayment takes from 15-30 years, or until you sell the home.
How much of your salary should go towards your mortgage?
There are a lot of tools available to help prospective homebuyers calculate how much of their salary should go towards their mortgage. The most accurate way to do this is through the pre-approval process, but there are some other things you will want to factor into this equation. You will want to consider your current and future lifestyle, debt, and any financial goals you have for your family. The last thing you want is to be house poor! The best mortgage advisors will gladly take these things into consideration when going through the pre-approval process.
Let’s imagine your household income is $8,000 pre-tax every month. After taxes, your take-home pay is $6,000. Here are three ways to calculate how much you can afford at that income level.
#1: The 25% post-tax calculation
Many lenders agree that your total monthly debt should be 25% or less of your post-tax take-home pay.
Imagine that after taxes are taken out, your monthly paycheck is $6,000. To calculate how much home you can afford in this scenario, multiply $6,000 by 25%, or 0.25. This leaves you with $1,500 to spend on your monthly mortgage payment (including principal, interest, taxes and insurance).
This model is the most conservative of the three, giving you less money to spend on a mortgage. However, the calculation will likely be the easiest to live with financially, especially if you’re still paying off other debt.
#2: The 28% pre-tax calculation
This method takes a different approach by looking at your income before any taxes are taken out. Here, it is suggested that you can comfortably spend 28% or less of your gross income on your mortgage payment each month.
The calculations are similar to the formula above. Imagine that before taxes are taken out, your monthly paycheck is $8,000. To calculate how much home you can afford in this scenario, multiply $8,000 by 28%, or 0.28.
This leaves you with up to $2,240 to cover monthly housing costs (not including repairs, upgrades, homeowners association dues, etc.).
#3: The 35% / 45% calculation
This model sounds more complicated, but it’s actually the more traditional way to determine what you can afford. The 35%/45% example says that you shouldn’t spend more than 35% of your pre-tax income or 45% of your after-tax income on your mortgage payment.
To estimate what you can afford using this model, multiply your gross monthly income (pre-tax) by 35%, and then multiply your monthly take-home pay by 45%. The total you can spend on a mortgage is somewhere between these two amounts.
Like before, your household income is $8,000 before taxes. Multiplying $8,000 by 35% or 0.35 gives you $2,800. And your take-home paycheck every month, after taxes, is $6,000. Multiply $6,000 by 45% or 0.45 resulting in $2,700.
Using this approach, you should have no problem with a mortgage payment between $2,700 and $2,800 per month, giving you more options on the types of homes you can consider.
Still confused? Talk to a Mortgage Advisor!
While the calculations above might be helpful, they are really just estimates. To really know how much of your salary should go to your mortgage, you have to factor in the other things mentioned earlier. For example, if you are looking to start a family, you might need to put more money away than if you plan on not starting a family anytime soon.