When you’re ready to shop for a home, you need to know how much you can afford. Many factors affect how much mortgage you can take on, many of which control the lender’s guidelines. Keep reading below to learn what affects your mortgage affordability.
The amount of your down payment determines how much you may borrow. At a minimum, borrowers must put down 5 percent on homes priced $500,000 or less and 10 percent on homes priced over $500,000.
For example, if you have $10,000 to put down on a home, your maximum loan amount assuming you can afford it is $200,000.
Debt Service Ratios
Lenders also look closely at your debt service ratios. These ratios compare your total debts to your monthly income. It shows lenders how well you can afford a mortgage payment.
Lenders look at two ratios – your gross debt service ratio and total debt service ratio. To be safe, borrowers may have a gross debt service ratio of 35 percent or lower and a total debt service ratio of 42 percent or lower.
Your gross debt service ratio is your mortgage payment, property taxes, and heating costs compared to your annual income. If you purchase a condo, it also includes 50 percent of your condo fees.
Your total debt service ratio is your total housing expenses from above plus credit card interest, car payments, and any loan payments divided by your annual income.
Can you Increase your Mortgage Affordability?
If your mortgage affordability is less than you hoped, there are a few ways to increase the amount:
- Pay off your debts – The fewer debts you have, the lower your total debt service ratio. If the TDS is the problem (it’s too high) consider paying your debts down or off to lower it and get the approval.
- Save more for a down payment – Do you have more money to put down on the home? Lenders look positively on borrowers with higher down payments than the minimum 5 percent.
- Take on a co-borrower – Are you buying the home with a spouse or another partner? Using their income (assuming they have good credit) may increase your affordability. Just make sure they don’t bring more debts to the table, making your TDS higher.
No matter what the ratios say, make sure you’re comfortable with your mortgage payment. It’s your payment for the term. Don’t take a mortgage payment you can’t afford, but don’t sell yourself short either. Find the perfect payment that fits in your budget without stretching you too thin, so you can afford the payment even if your current financial situation changes.