If you’re paying more than $1,600 for rent in Austin, you can probably afford a mortgage on a house. The question then is; exactly how much house can you afford?
If you’re buying a home in cash, the answer to this question is simple: how much cash do you have? That’s how much house you can afford. However, if you’re like most American homeowners who get a home mortgage, your affordability is largely based on your DTI, or debt to income ratio.
Lenders use the formula below to make sure that the loan you say you want is a loan you can actually pay back every month.
All monthly debt payments ÷ gross monthly income = DTI ratio
Here’s how to calculate your own DTI to find out how much home you can afford:
Step 1: Add up your monthly expenses, including:
• Your monthly rent or mortgage payment
• Monthly student loan and auto loan payments
• Any other monthly loan or financed payments
• Minimum monthly credit card payment
• Alimony or child support
There may be additional debts that your lender will include, but these are the basics.
For example: Let’s say Bob Buyer rents a place for $1,500 per month, pays $250 towards his student loans each month, owns his car outright ($0) and has two credit cards that he pays off each month, but both have a $25 minimum payment. His total monthly debt equals $1,800.
Step 2: Divide your total monthly debt by your total gross monthly income (income before taxes).
The result should be a decimal or percentage, which represents your debt to income ratio.
In our example, pretend that Bob Buyer brings in $5,500 per month in pre-tax income. When we divide his monthly debt of $1,800 by his monthly income of $5,500, we get a debt to income ratio of 0.32, or 32%.
Generally, the max DTI allowed is ~45%
Once you have your current DTI figured out, you can plug in different numbers for your hypothetical monthly mortgage amount to see the max you could pay each month while staying under 45% DTI. From there use an app like this one to see how that monthly payment translates to a purchase price.
To learn more about buying a home, contact us!
September 8, 2018