Many factors go into making a decision about the home price you feel comfortable with. One of the key factors is understanding what a lender will pre-approve you for and why you have been pre-approved for that amount.
When preparing for homeownership, it is important to approach this financial decision with two different lenses:
a) What price mortgage will a lender pre-approve me for? Essentially: what does the lender see and believe about my financial picture and homebuying potential?
b) What price home can I comfortably afford and feel good about? Essentially: what is the maximum amount I am willing to pay per month, taking into consideration my financial goals, expenses and comfort level?
In this guide, we’ll dig into Part A (see our Landed Learning guide for creating a monthly budget to answer Part B).
Lenders collect different pieces of information to understand your full financial picture. When you apply for a mortgage, you will need to report all of your income, assets, and debt information, and your lender will review your credit history. These factors together determine how much they are able to lend you and at what interest rate. Read more about what information a lender needs to give you a mortgage pre-approval here!
Calculate your debt-to-income ratio using this helpful resource. Lenders will use your debt-to-income ratio to assess whether or not you qualify for a mortgage and if so, how large that mortgage can be.
Understanding Debt-To-Income Ratio
How do lenders determine the mortgage I can afford?
To determine your loan amount, one of the big factors a lender looks at is your Debt-to-Income Ratio (or DTI). As a good rule of thumb, Landed’s participating lenders typically like to see a DTI of 40-41% with a max of 43% (this means they will not allow your debt, including your mortgage payments, to go above 43% of your pre-tax household income).
Calculating Your DTI Ratio:
- Add up your monthly debt costs – Student, auto, or other monthly loan payments. Credit card monthly payments. Current rent or mortgage*.
Divide your monthly debt by your household pre-tax monthly income – Salary, child support, alimony, and other income.
Multiply the result by 100 to get your percentage (or ratio) – ((Monthly Debt)/(Monthly Income)) x 100 = DTI (Debt to Income Ratio)
*Remember your current rent payment or mortgage is not actually included in your DTI calculated by the lender. They instead use the max mortgage limit they are pre-approving you for. Using your current rent or mortgage payment amount in your own calculations can help you know if your new monthly mortgage expense would potentially be the same, higher, or lower.
Estimate Your Monthly Mortgage Payment Maximum:
Although your DTI is often the most helpful tool to determine what you might qualify for, another rule of thumb is the 28% guideline. This says that your mortgage payment (including property tax, homeowner’s insurance, and potential HOA fees) should not be more than 28% of your pre-tax income.