Whether a client is a first-time buyer, moving for retirement, purchasing a second home, or selling to buy another home, most will ask this question: “How much house can I afford?” Actually, the answer is based on several factors: House payment, down payment, home prices, debt level, credit history, income, and possibly even location. Understanding these factors will help make buying a home much easier.

How Much House Can I Afford?

Again, a very popular question. Knowing this answer helps a buyer:

• Know the total housing payment
• Shop with confidence
• Compete with other buyers
• Win over a seller

Too often, buyers get the process backward and will sometimes even go under contract prior to loan pre-approval. This is not the way to go!

Scenario 1: Getting under contract without loan approval up-front: This can cause any or all of the following: Miscalculating house payment, not aware of qualifying issues like income or credit, forgetting seller paid costs so short funds to close or being rushed through closing because of starting the mortgage process too late.

Scenario 2: Get pre-approved up-front, prior to contract. Payment fits within budget, potential qualifying issues have been remedied, purchase offer strategy created (seller paid costs, time to close), makes a solid, specific offer that works for the buyer’s scenario and gives a seller confidence in choosing the offer.

Scenario 2 is the way to go! It may not be so obvious until you actually read it like this. It’s like going to take a final exam and never taking the class or studying. Why would you do this? Sure, you may get lucky with some answers, but chances of passing are low. Scenario 2 gives a buyer the best chance of success. In such an important financial decision, why do it any other way?

What Will My House Payment Be?

Simple question, but so many factors go into the answer. That’s why using an online mortgage calculator doesn’t always give the right answer. It can give misleading information because the calculators do not know your credit score, debt ratio, property taxes and insurance, among other key factors.  When buying a home, buyers need accurate information up-front to make this important financial decision. Want to learn more about how the payment works? Check out another one of our articles titled, “Mortgage Calculators – What Will My House Payment Be?“.

How Much Down Payment For a House?

Unfortunately, many still believe 20% is the required down payment on buying a home. Although buyers may put down this much, most of the time it is not required. There are so many options for buyers to put no money down, low money down, or a larger down payment. Other than some of the down payment assistance options, most loans aren’t just for first-time buyers as well. A few examples that empower buyers are:

VA Home Loans:

Often requires zero down payment, even when having two VA loans at once. Additionally, the seller often covers most or all of the closing costs. VA allows for the seller to pay off a Veteran’s debts, current lease, and more. VA even offers larger loan sizes that usually require a lower down payment than a conventional jumbo loan.

USDA Guaranteed Loans:

USDA is a no money down loan that does have a household income limit, although it is very reasonable. Plus, it has property eligibility restrictions in that the home must be located in a USDA eligible area. Luckily, most of the U.S. is eligible. The seller is also able to pay up to 6% of the sales price towards buyer closing costs.

FHA Loans:

This is one of the most popular loans that allows for a low down payment, flexible qualification, and no area or income restrictions. FHA also allows for 6% seller paid costs and the down payment may come from many sources.

Conventional Loans:

Fannie Mae and Freddie Mac loans allow for as little as 3% down payment which may even come from a gift. Buyers may choose to put down 5, 10, 15, 20% or more if they choose.  Then, these loans may be used for buying a second home or investment property.  Also, buyers with student loan debts may find that Fannie and Freddie guidelines make it easier to qualify. Seller paid costs are allowed and depend on the loan type and down payment percentage.

Down Payment Assistance Loans:

These financing options bridge the gap between the purchase price and the loan amount. Thus, making the purchase a no money down or very low out of pocket. Furthermore, the funds may be used towards buyer closing costs. Each state offers their own DPA options, so check with us for which match your scenario.

Renovation Loans:

Whether called rehab, renovation, or home improvement loans, this loan type allows a buyer to include their HGTV dream improvements while buying a home. Eligible renovation loans include VA renovation loan, FHA 203k, and the Fannie Mae Homestyle Renovation. Each has their strengths and offer the ability to finance improvements into the purchase money loan. Another factor includes being able to pay the same percentage down. For instance, the FHA 203k is still 3.5% down of the price and improvements. Our Renovation Department provides the knowledge necessary to walk a buyer through this process with more confidence.

Home Prices Affect Buyer Qualification

One thing to remember is that all house prices are not created equal. That means that a $200,000 house in one area may have a different total payment than another. Obviously, the purchase price is a key factor and in most areas, home prices continue to climb. Increasing home prices greatly affect buyers and especially first time buyers, but don’t forget about property taxes, insurances, and possibly association dues.  Property taxes may include city, county, and even other miscellaneous charges. Therefore, a home outside the city limits should have lower taxes. Although, other costs could be higher. Sometimes in states like SC, the occupancy of the home influences the level of taxes.

Next, there is insurance. This could include homeowners insurance, wind & hail coverage, and flood insurance. The geographic location and proximity to high-risk areas determine not only the requirement for each but also the cost. Basically, the higher the risk, the higher the insurance premium. There could also be homeowners association dues or HOA dues. These are charges from a subdivision for certain amenities such as common ground, maintenance, improvements, or even insurances. While considering a home purchase and wondering how much house you can afford, always factor these costs into the decision!

Debt Level Affects How Much House You Can Afford

Lending guidelines for all mortgage types care about the total amount of debt payments compared to a borrower’s income. This is called the debt to income ratio. Typical debts included in the debt to income ratio include the following:

• Installment loans (auto, student, unsecured)
• Revolving accounts (credit cards, lines of credit)
• Mortgages
• Taxes, insurance, and association dues (even on free and clear properties)
• Alimony and child support
• Income tax installment agreements
• Childcare (only factored in VA loans)
• Utilities (only factored in VA loans)

FYI, debt ratios do not factor retirement account loan payments. Lending agencies have approximate limits on debt to income ratios. Many programs allow up to 50 – 55% debt to income ratios, but it does depend on the program and the borrower’s overall scenario. Often automated approvals determine the level of ratio allowed. Therefore, the more strengths a buyer has, usually the higher the ratio allowed.

Credit Scores and History Factors

Credit is one of the largest factors of a purchase approval, although lenders cannot go by credit alone. Even if a buyer knows that a payment has never been missed in their life, there could be issues. A Brookings’ article finds, “More than one in five consumers have a “potentially material error” in their credit file that makes them look riskier than they are.” Additionally, many do not realize 30% of a credit score is comprised of the relationship of balances compared to credit limits on revolving accounts. Thus, a buyer could have no late payments but have $450 balances on 3 separate cards with $500 limits each, and it could have a significant, negative effect on the scores.

One of the first steps in answering the question, “How much house can I afford?” is the credit report review. Our loan officers are trained to review and recognize opportunities to help buyers. Even going from 720 to 760 could make a positive difference in approval. Obviously, this is another reason to complete the process up-front with your loan officer.

Gross Monthly Income – How Much House Can I Afford?

Mortgage lenders and banks must follow the federal “Ability To Repay Rule.” Thus, buyers must qualify for the chosen financing option. Figuring income is not a cookie cutter process. Often, there are so many variations of income sources. So, answering the question “How much house can I afford?” is not so easy. Examples include bonus, commission, overtime, interest and dividends, retirement, annuity, rental, second jobs, and much more. Typically, many of these income sources require a certain history plus a reasonable expectation for each to continue, but there are ways to count brand new income such as salary or base hourly pay. This includes employees just out of college or transferring to a new job.

Typically, lenders go by the gross monthly calculated income. Yet, self-employed borrowers complicate things. Lenders calculate the income by using 1 – 2 years of tax returns. This process requires adding and subtracting certain amounts to or from the bottom line profit. There are also some alternative income programs such as bank statement loans which allow buyers to prove income as cash flow rather than using the actual amount on a tax return.

How Much House Can I Afford – Property Eligibility:

Property eligibility typically means 3 things. First, is the type of property. This includes property types like condos, townhomes, manufactured, modular homes, single family, duplex, log homes, multi-family homes, and more. Some property types like condos and manufactured require their own set of qualification guidelines. Others like log homes require appraisals compared to similar log home recent sales.

Second is the geographic location of the property. This is important for certain programs like USDA or Down Payment Assistance. In order to qualify for a USDA loan, the property must be located in a USDA eligible area. If not, USDA makes no exception in this area. Other programs like DPA require that the property is located in a certain state or city.

Finally, there is the property condition. Generally, government loans like FHA, USDA, and VA are more strict on condition than conventional loans. Luckily, if there are property condition issues and repairs are required, that’s where a renovation loan helps.

How Much House Can I Afford Next Step

Hopefully, after reading this article, it is easier to see that the answer to “How much house can I afford?” starts with calling an OVM Financial loan officer. The purchase process without a licensed loan officer can be a minefield with unexpected traps along the way. Even with a loan officer, there are situations that pop up out of the blue. With an experienced loan officer (and not just a call center rep) that has seen most scenarios, a buyer better understands the qualification up-front. Plus, the buyer is better prepared to make a solid offer for a new home and is in a position to close on time. Want to learn more? Check out other informative articles throughout this blog.