If you're looking to buy a home, your first question is likely "How much home can I afford?".
The answer largely depends on how large of a mortgage you can get, and how large your monthly payments can be.
How Much Can You Afford When Buying A Home?
By understanding the lender’s perspective, you can estimate each of these amounts and get your home search moving faster. Lenders will look at three figures in order to determine your maximum loan amount and your interest rate: Debt-to-Income Ratio (DTI), Loan-to-Value Ratio (LTV), and credit score.
Debt-To-Income Ratio (DTI)
This number helps the lender to determine what percentage of your income can be used to pay your monthly debt obligations. You can calculate your DTI ratio by adding all of your monthly debt obligations, and dividing that number by your gross monthly income. Lenders like to see a lower DTI ratio because this indicates that you will be more likely to fulfill monthly mortgage payments. Generally, a 43% DTI ratio is the highest the lender will allow for a qualified mortgage.
Loan-To-Value Ratio (LTV)
LTV measures what percentage of the home’s value is being purchased with your mortgage. 40% LTV of a $300,000 home means that you are getting a $120,000 mortgage (because $120,000 mortgage / $300,000 home value = 40%). The higher the LTV rate, the more risk that exists for the lender. That means the lower your LTV, the less risk for your lender, which decreases the overall interest rate you pay for your loan. An 80% LTV or lower is considered ideal for homebuyers.
Lenders use your credit score to determine your likelihood of paying your dues on time. This is a score between 300 and 850 and is based on your credit history. You will need a credit score of at least 620 to qualify for most mortgage products. If you are below 620 but above 580, we recommend you apply for an FHA loan. A higher credit score tells the lender that you have lower risk of default, and will give you lower interest rates for your mortgage. There are many online services that allow you to view your credit score for free.
Bottom Line about how much you can afford
At the end of the day, the one question lenders will ask after looking at these three numbers is "will this person be able to pay back both the principal and interest for the duration of the mortgage?"