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Crunching the Numbers: Understanding Your Home-Buying Power

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 2 minute read

Published: Tue Apr 18 2023

By Sean Hundtofte, Ph.D., Former NYU Adjunct Assistant Professor, Financial Economist at the Federal Reserve Bank of New York, Chief Economist and Head of Acquisitions at Better.com, Former Portfolio Optimizer at Bridgewater Associates - Expert in Financial Economics and Mortgage Lending Solutions

Buying a home is a significant investment that requires careful consideration of your financial situation. As a potential homebuyer, you need to understand how much house you can afford and what factors determine your home-buying power. Fortunately, with the help of unbiased mortgage advice and some financial planning, you can make a sound decision and achieve your homeownership goals. This article will help you understand the factors that determine how much house you can afford and lead you on the path to buying the home of your dreams.

Debt-to-income ratio (DTI)
This ratio is the percentage of your gross monthly income that goes toward paying off debt. To calculate your DTI, divide your total monthly debt payment by your gross monthly income. For example, say you have a gross monthly income of $6,000 and your monthly debts (rent, student loans, credit card payments) add up to $1500. Your DTI would be 1500/6000 = 25%. Lenders use this ratio to assess your ability to manage debt and make mortgage payments. Ideally, your DTI is below 36%. However, it’s worth noting that in some circumstances, DTI can reach up to 50%, and many lenders are willing to accept higher ratios, provided you have a stable income and a better credit score.

Credit Score
Your credit score reflects your creditworthiness and tells lenders how likely you are to repay a loan. The higher your credit score, the better your chances of getting a lower interest rate and favorable loan terms. You can improve your credit score by paying bills on time, keeping your credit card balances low, and checking your credit report for errors.

After You Assess Your Financial Situation → Unbiased Mortgage Advice
One important factor to consider when evaluating your home-buying power is the opportunity cost of homeownership. Opportunity cost refers to the potential benefits you give up by choosing one option over another. In the case of homeownership, you are giving up the option to rent (and potential returns of investing a downpayment elsewhere). For example, if you have a choice between putting a large down payment on a house or investing that money in the stock market, you may want to consider the potential returns and risks of each option. While homeownership has its advantages, including tax deductions on mortgage payments and emotional benefits like stability and avoiding conflicts with your landlord, your financial situation and market conditions may suggest renting right now.

Down payment
The down payment you make on a house is another important factor in determining how much home you can afford. Generally, the larger your down payment, the less you'll have to borrow, and the lower your monthly payments will be. While some lenders may accept as little as 3% down payment, if you make a 20% down payment you avoid paying any private mortgage insurance (PMI). PMI simply increases the cost of your monthly payment for a home. The bottom line is: the less money you put up front, the more you pay in monthly costs. You can always refinance a mortgage with PMI in the future once you’ve built up equity, so not having a lot of cash up-front should not deter you from exploring homes that may seem beyond your buying power.

Income and job security
Lenders want to see that you have a stable income and a solid employment history before approving a mortgage. If you're self-employed or have irregular income, you may have to provide additional documentation, such as tax returns, to prove your income.

It is important to remember that everyone’s financial situation is unique and there are other factors that come into play when determining how much house you can afford. If you're looking to buy a home and want to make sure you're considering all the variables, there's a tool that can help you out. Check out Solve Finance’s Mortgage Optimizer! It's a handy tool that can guide you through the more intricate financial aspects of the home buying process, and give you unbiased mortgage advice as you shop for the best mortgage product for your new home.

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