Melvin Feller Discusses How to Determine How Much Home You Can Afford
Melvin Feller Discusses How to Determine How Much Home You Can Afford
Melvin Feller Business Group in Burkburnett Ministries and Dallas Texas and Lawton Oklahoma. Our mission is to call and equip a generation of Christian entrepreneurs to do business as ministry. We provide workshops and resources that help companies discover how to do business God’s way and provide a positive outreach as the director. When the heart of a business is service rather than self it can be transformed into a fruitful business ministry earning a profit and being of service to the community and their customers. Melvin Feller is currently pursuing another graduate degree in business organizations.
When the time is right to purchase a home, the first question you need to be able to answer is how of a home you can afford. Knowing the answer to this question will allow you to focus your search on homes within the correct price range even before applying for a mortgage.
The most important factor that lenders use as a rule of thumb for how much you can borrow is the debt-to-income ratio. This ratio takes into account a mortgage payment plus your other personal debt you are carrying such as car loans, credit card debt and student loans. The ratio is expressed in a percentage of how much of your income is being used to make debt payments.
The typical guideline used by most lenders is a ratio of 36% as the upper limit. Ratios above this may carry a higher interest rate or be denied altogether. Lenders also like to see that generally no more than 28% be dedicated to all housing expenses.
Calculating Your Debt-to-Income Ratio
The first thing you need to do is determine your gross monthly income. This is the income before taxes and other expenses are taken out. If you are married and will be applying for the loan jointly you should add together both incomes. Then take this number and multiply it by 0.36. For example, if you and your spouse have a combined gross monthly income of $7,000:
$7,000 x 0.36 = $2,520
This means that your total monthly debt payments should be no more than $2,520, mortgage payment included.
The next step is to determine your total non-mortgage debt payments such as monthly credit card or car payments. For this example, we will assume your monthly debt payments come to $950. Computing the maximum mortgage payment:
$2,520 — $950 = $1,570
From this example, we have determined that the most home you can reasonably afford is one with a mortgage payment of $1,590, which would include property taxes, insurance and possibly private mortgage insurance.
Remember, this is Only a Rule of Thumb
It is important to remember that just because the bank will lend up to that amount does not mean that is what you can truly afford. This is simply a guideline you can use when shopping for a home so you are concentrating on homes that are within your price range. In reality, your specific situation will dictate what type of home and mortgage payment will be best for you.
Two major components of tracking how you are doing financially can be broken down into your income and debt levels. Obviously, you would like to have more income coming in than debt payments going out, but even if you are making more money than you owe, how can you tell if that is good enough? That is where the debt to income ratio can come in handy. This quick calculation can give you an idea of where you stand and can be helpful in helping you with other financial decisions such as figuring out how much money you can borrow to buy a house.
Ratios as a Financial Litmus Test
Financial ratios do not give you a terribly detailed picture of your financial situation, but they can be used to quickly gauge how you are doing. In addition to the debt to income ratio, another easy ratio to calculate is your net worth. With net worth, you are essentially adding up all of your assets and measuring them against all of your liabilities. A positive number means you have more assets than liabilities while a negative number means you have more liabilities than assets. This number can help you track your financial progress from year to year.
Not only is the net worth calculation useful, but your debt to income ratio can come in very handy. In fact, it is even used by many lenders to determine whether to extend financing if you are requesting a loan. If you have a head start and already know what your debt to income ratio is, you will be better prepared to find the loan that is right for you.
Calculating Your Debt to Income Ratio
Calculating your debt to income ratio is as simple as adding up all of your debt and subtracting it from your income. Some calculations may exclude things like mortgage payments and property taxes, but to really get a complete picture it is best to include everything.
So, to get started, take a moment to gather all of your monthly debt obligations. This will include monthly payments such as:
Mortgage payment (including taxes, insurance, private mortgage insurance, etc.)
Minimum credit card payment
Student loans payment
Any other monthly debt obligations
When you add these all up, it will give you your total monthly debt payments. Keep this number handy, as we will be using it in just a minute.
Next, you need to calculate your monthly income. Start with your monthly salary. If you receive any additional bonuses on a yearly or quarterly basis, be sure to divide it out to get the per month number. Finally, add up any additional income you receive, whether through dividends, a side business, or whatever the case may be. Total these all up and you will have your total monthly income.
Now comes the easy part. To determine your debt to income ratio simply take your total debt payment number and divide it by your total monthly income. That equals your debt to income ratio. For example, if you came up with a $2,000 total debt payment number and monthly income of $6,000, that leaves you with a debt to income ratio of 33%.
Why Debt to Income is Important
Therefore, you have calculated your debt to income ratio, but what does that number mean? Obviously, this is a number you want to be as low as possible. The less debt you have relative to your income, the better off you are financially since you have extra money to apply toward other goals. However, it is also important in terms of deciding how much of a house you can afford.
Lenders tend to look at two key debt to income ratios when it comes to mortgages. First, they look at the front ratio, which is the debt to income ratio that includes all housing costs. Then, there is the back ratio, which looks at your non-mortgage debt to income ratio. Lenders would like to see your front ratio at 36% or less and your back ratio at 28% or less.
Keep in mind that these ratios are only guidelines and there are many other factors that go into determining how much you can borrow and at what rate. But if you want to have a general idea of what’s to be expected, you can play with these numbers to see where you stand and how you can improve your situation.
Your debt-to-income (DTI) ratio gives you an indication of how high your debt is compared to your income. The lower your DTI ratio, the better. Lower DTI ratios mean you do not spend much of your income paying debts. On the other hand, a DTI ratio would mean much of your income is being put toward debt, leaving you without very much money to spend or save.
What is a High Debt-To-Income Ratio?
If your DTI ratio is more than 50%, you definitely have too much debt. That means, you are spending at least half your monthly income on debt. Between 37% and 49% is not terrible, but those are still some risky numbers. Ideally, you want to have a DTI ratio that is less than 36%. That means you have a manageable debt load and money left over after making your monthly debt payments.
How to Reduce Your Debt-to-Income Ratio
There are times when having a high DTI ratio makes sense. For example, it is usually ok to have a high DTI ratio if you actively paying off your debt. However, if your ratio is high and you are only making minimum payments that is a problem?
Generally, there are two ways to lower your DTI ratio. First, you can increase your income. That could mean working some overtime, asking for a salary increase, taking on a part-time job, or generating money from a hobby. The more you can increase your monthly income (without simultaneously raising your debt payments) the lower your DTI ratio will be.
The second way to lower your ratio is to pay off your debt. Once your debts are paid off, your debt-to-income ratio will drop dramatically. However, while you are in debt repayment mode, your DTI ratio will temporarily increase. That is because a higher percentage of your income will be going toward debt. For example, if your monthly income is $1,000 and you currently spend $480 on debt each month, then your ratio is 48%. If you decide to spend $700 a month on debt payments, then your ratio would increase to 70%. However, when you have paid the debt all the way off, your ratio would drop to 0% because you would no longer spend your income on debt.
Melvin Feller Business Consultants Ministries Group in Texas and Oklahoma. Melvin Feller founded Melvin Feller Business Consultants Group and Burkburnett Ministries in the 1970s to help individuals and organizations achieve their specific Victory. Victory as defined by the individual or organization are achieving strategic objectives, exceeding goals, getting results or desired outcomes and a positive outreach with grace and as a ministries. He has extensive experience assisting businesses achieve top and bottom line results. He has broad practical experience creating WINNERS in many organizations and industries. He has hands-on experience in executive leadership, operations, logistics, sales, program management, organizational development, training, and customer service. He has coached teams to achieve results in strategic planning, business development, organizational design, sales, and customer response and business process improvement. He has prepared and presented many workshops nationally and internationally.