One of the most important factors to consider when purchasing a home is affordability. Affordability can look different for each person considering homeownership.
Homeownership affordabilityis defined as the ability to purchase and maintain a home without experiencing financial hardship in covering monthly obligations, including the mortgage payment. Generally, a mortgage is considered affordable when a household spends no more than 30% of its gross monthly income on housing expenses, including mortgage payments, property taxes, insurance, and incidental costs such as homeowner association dues. This 30 percent threshold is commonly recommended by financial institutions and housing counselors.
Charlestien Harris
Another method to determine affordability is the 2.5 rule. You might ask, “What is the house affordability rule?” This rule suggests choosing a home priced at about 2.5 times your annual household income. It serves as a guideline to help estimate how much house you can afford.
Once you’ve decided to pursue homeownership, there are several steps you should take to make your dream a reality. Let’s explore the process:
1. Estimate Your Total Monthly House Payment
Several components make up a mortgage payment. These include principal, interest, taxes, and insurance – commonly referred to as PITI in the homebuying process.
Principal is the amount you pay each month to reduce the loan balance.
Interest is the cost of borrowing the money.
Property taxes are part of the real estate transaction and may be included in your monthly payment or paid separately.
Homeowner’s insurance is required and can also be included in your mortgage payment or paid separately.
You’ll have the option to decide how these costs are handled when determining your affordability.
2. Estimate the Percentage of Income Dedicated to Your Mortgage
Understanding how much of your income goes toward your mortgage is crucial. It helps you create a budget and assess how much additional debt your income can support. A common rule of thumb is that your total monthly mortgage payment should not exceed 28 percent of your gross monthly income. This is known as the front-end housing ratio, calculated by dividing total monthly housing expenses by gross monthly income.
3. Estimate How Much Income Remains for Other Obligations
Next, calculate how much income remains after accounting for your housing costs. This step helps determine whether you’re financially ready to purchase a home. This is known as the back-end housing ratio or debt-to-income (DTI) ratio. It is calculated by dividing your total monthly debt obligations (including housing, car payments, student loans, and credit cards) by your gross monthly income, then multiplying by 100 to express it as a percentage.
4. Estimate the Down Payment and Closing Costs
Saving for a home can be challenging, especially when money is tight. Start early by opening a savings account dedicated to these costs. Saving thousands of dollars takes time, but the more you save, the closer you are to homeownership.
You may also qualify for down payment or closing cost assistance programs. These programs, offered by various agencies and financial institutions, can provide grants or loans to help cover these expenses. Research the requirements and application steps to take advantage of these opportunities, which can free up your savings for other home buying costs.
5. Review Your Loan Estimate
A loan estimate is a standardized document that lenders provide to potential homebuyers. It outlines the estimated costs and terms of a mortgage loan, including the loan amount, interest rate, monthly payment, and closing costs. This document helps you compare offers from different lenders and choose the most favorable terms.
Lenders are required to provide a loan estimate within three business days of receiving a completed mortgage application. The form uses clear language to help you understand the loan terms. Don’t underestimate the importance of this step – it can save you both time and money.
Mortgage affordability is a critical part of the home buying process, and knowing your numbers is just as important. Being financially prepared can help you navigate the process more efficiently and avoid costly surprises. By following the steps outlined above, you can get a solid estimate of how much home you can afford.
To help you calculate your estimated monthly payments based on your income and details, Southern Bancorp offers a free mortgage calculator at banksouthern.com/mortgage, where you can also find a mortgage lender near you who will be happy to answer any questions you may have about homeownership.
For more information on this and other financial topics, feel free to email me at charlestienharris77@gmail.com or write to me at P.O. Box 1825, Clarksdale, MS 38614.
Until next week – stay financially fit!
Charlestien Harris is our financial contributor, a retired financial expert with Southern Bancorp Community Partners.
