Once you have finally decided to take the leap into homeownership, the next logical determination is figuring out how big of a mortgage you can actually get. This is the most important step in narrowing your search for attainable housing because as much as we all love to dream about mansions full of money, the majority of buyers would be hard-pressed to find a lender willing to finance a fantasy.
So, how do you make sure you aren’t taking too big of a leap and buying a house outside your budget? Listen closely to what your lender says as they determine how large of a loan you are eligible for. It may also help to take a quick walk through some common financial acronyms you are bound to hear along the way, all of which are key factors in determining just how big that mortgage can be.
The combined total monthly payment including all principle, interest, taxes and insurance (both homeowner’s insurance and private mortgage insurance when applicable) is referred to as PITI. This final monthly amount should be 28% or less of your total gross monthly income, and while you might find a bank willing to finance you above this threshold, it is generally not advisable. It puts borrowers at a much larger risk of default and will also most likely set your mortgage at a higher interest rate.
To determine a borrower’s debt-to-income ratio, or DTI, all monthly debts, including auto loans, mortgages, student and personal loans, are added up and then divided by the total gross monthly income. Reminder: your total gross monthly income is the amount earned prior to any taxes, retirement contributions or other deductions. The routine standard for DTI is 36% or lower. Though loans may still receive approval with DTI’s above these recommended limits, again, borrowers working outside of these norms will likely receive much steeper interest rates. Additionally, they are putting themselves in potentially difficult financial positions as a greater amount of their income is consumed by payments.
The final acronym homebuyers in need of a mortgage must understand is LTV or Loan to Value ratio. This number expresses the amount of the loan divided by the appraised property value (APV). For example, a home that needs financing of $75,000 that has appraised at $100,000 will have an LTV of 75%. In general, most banks will approve loans for borrowers up to 80% of the appraised value; however, it is possible to finance up to 90% of the APV by also purchasing private mortgage insurance (or PMI). You can also manipulate this number by increasing your down payment and lessening the amount needing to be financed should the appraisal come in lower than expected.
One more factor influencing how large of a mortgage homeowners are able to secure comes down to the almighty credit score. A borrower’s credit score can greatly affect the amount a bank is willing to lend. Buyers with scores at 680 or above are typically provided a “normal” interest rate while borrowers who fall below this preferred number are subject to higher interest rates and fees.
There are multiple factors at play in determining how big of a mortgage a homebuyer will receive, and buyers looking to finance properties outside their reach may end up paying premium rates in order to obtain those dream homes. It’s usually best to play it safe, though, and work to find a house within your means, one that will not require extreme interest rates and additional monthly fees. At the end of the day, a house is just a house. It is the people inside of it, not the amount of the mortgage, that make it valuable.
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