Before you even start looking for a home, you need to know exactly how much home you can afford – otherwise, you could spend time looking at homes that are out of your price range. If that happens, it's hard not to be disappointed later when you view less expensive homes.
To get an idea of what you can afford, you'll need to take into account the following:
- Your down payment
- Your household income
- Your current debts (liabilities) and your monthly payments associated with those debts
- Your estimated monthly housing-related costs, including mortgage payment, property taxes, property insurance, condominium fees, school taxes, utilities and maintenance costs
- Your anticipated closing costs and other one-time costs
- Your current spending practices
Look closely at ALL your expenses.
You've got to put food on the table, clothes on your back and gas in your car-and have a little fun now and then. You also need to be prepared for emergencies as well.
Your mortgage specialist will help you make sure you have money left over to pay for the necessities of life, as well as some of your lifestyle choices. The following calculations are used by most lenders as a guide to help determine the maximum you should spend on housing costs and overall debt levels:
- Gross Debt Service (GDS) Ratio. No more than 30% to 32% of your gross annual income should go to "mortgage expenses"-principal, interest, property taxes and heating costs (plus fees for condominium maintenance).
- Total Debt Service (TDS) Ratio. TDS evaluates the gross annual income needed for all debt payments-house, credit cards, personal loans and car loan. Depending on the lender, TDS payments should not exceed 37% to 40% of your gross annual income. The combined incomes for you and your spouse are usually considered, when determining this ratio.
If your monthly housing and housing-related costs don't leave you enough money for your other expenses, then you have a few options.
- First, see if you can reduce any of your "lifestyle" expenses. Maybe you'll travel less, eat out less often, or buy fewer clothes to improve your cash flow.
- Second, take into account short-term expenses that will go away. Maybe you'll be paying off a car loan in a year or so. Or your children will soon be starting school-eliminating (or reducing) your child-care expenses.
- Third, seek out lower-priced homes that still meet your needs, but also allow you to afford both your home and everyday living expenses.
You and your mortgage specialist may also need to factor in expenses or changes that you know are on the horizon. Maybe you'll need to replace your car within the next year. Or if you're expecting your first baby you may need to consider the impact of a maternity or paternity leave on your budget in addition to expenses related to having a baby.
When all is said and done, you need to feel comfortable with your mortgage amount, term and payment schedule. And you want to feel good about any sacrifices that you choose to make.