If you're like many first-time homebuyers, chances are you've been spending your weekends driving around visiting open houses and shopping on the web. This is a great way to get a feel for what you want. The problem is, 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 29 percent of your gross monthly income goes towards housing expenses.
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.
How much can you afford?