While Sarah browsed online through homes for sale, she thought to herself “How much mortgage can I qualify for?”. She decides to search online for a mortgage calculator, which she is able to find dozens of them immediately. She plays around with the calculator to see the estimated mortgage payment of a few homes for sale that she likes. However, she still isn’t sure of the actual price of a home she can qualify for with her salary.
Sarah thinks about asking a lender how much she can qualify for, but she is not quite ready to take that step yet. Lenders will usually ask for your bank statements, tax returns for the past few years, etc. Sarah isn’t even sure if she wants to buy a home, so she doesn’t want to spend all that time gathering up that paperwork. Also, she doesn’t want a lender to run her credit, because a hard inquiry will drop her credit by a few points. She just wants to get a quick estimate of how much of a mortgage she can afford based on her yearly salary.
If you are in the same position Sarah is in, then you’ve come to the right place. When you start looking for a home, the first thing you need to know is how much of a mortgage you can qualify for. Without knowing what price you can afford however, it is very hard to start looking for homes. On the same token, no one wants to speak with a lender and fill out an application to get pre-approved until the very last minute. It is like visiting the doctor, or the dentist: most people do not bother until they absolutely have to. However, to avoid wasting a lot of time, you should find the answer to this question: “How much mortgage can I afford?”.
While the best way to know how much you qualify for is to speak with a mortgage lender (which I recommend for anyone who is serious about buying a home), I do get it. People just want to look at homes, imagining a better future while moving into their new place. You may not be ready to gather all your check stubs, W-2 forms, and tax returns yet. That’s why I will give you a way to estimate how much house you can afford. This way you can have a better idea of what homes you can look at, versus homes that are most likely too expensive for you.
See How Much Mortgage You Can Qualify For!
Here is the link to the price estimator, where you can get an estimate of how much mortgage you can qualify for as well as the estimated mortgage payment. To fill it out, you need the following info:
Gross Annual Income = The amount of income you receive yearly before taxes.
Monthly Debt = The total amount of debt you pay each month. This includes mortgages, car payments, credit card payments, personal loans, etc. Do not include any utilities, phone bills, or cable bills. Only include payments resulting from money you borrowed.
Down Payment (in percentage) = The percent of the purchase price your loan requires. FHA loans require a 3.5% down payment, while conventional loans can range anywhere from 3% to 20%. If you don’t know what percentage you want to use, use 3.5%.
Property Taxes = The taxes on the property. The average property taxes in Illinois is around 4000, so use that number if you do not have a particular house in mind. If you do have a home in mind, use the taxes for that specific property
Homeowner’s Insurance = The amount of homeowner’s insurance you have to pay each year. The average insurance is around 1000 in Illinois, so feel free to use that if you aren’t sure.
Interest Rate = The interest rate of the loan. As of December 2020, interest rates are averaging around 3%, so use that if you aren’t sure. Visit Bankrate.com to find exactly what today’s interest rates are.
Life Span of Loan = The number of years you will pay your loan. For mortgages, it is usually 30 years or 15 years.
The price you can afford depends on the taxes of the property as well as the amount of insurance you have to pay. The taxes & insurance are different for each property, so this is something you have to keep in mind. For example, you can afford a higher price on a home with 3000 in taxes per year versus a home that has 10,000 in taxes per year.
To make things easier, you can estimate the property taxes and insurance. The average amount of yearly taxes in Illinois is around $4000, so we’ll use that for taxes. The average homeowner’s insurance bill is around $1000, so we will use that number as well. The last number you need is an interest rate, which we can estimate at 3% for now. Next, lets dig into the what actually determines how much mortgage you can afford.
The main factors that determine how much mortgage you can qualify for are your income, your debt (how much money you owe), and your credit score (how well you pay your bills & monthly debts). Lets take a look at each factor to see how it will affect your mortgage.
Credit
Your credit, or your credit score, is what lenders look at to determine how well you pay off your bills. Lenders want to see that you pay back your debts on time, and your credit score is your proof. Not only does your credit score determine where you can qualify for a mortgage, it also determines what interest rate you qualify for. Having a higher credit score will lower your interest rate. The lower your interest rate, the lower your mortgage.
Your credit score will range from 300 (really bad) to 850 (perfect). The minimum credit score you need to qualify for a mortgage is 580. However, lenders will charge you a higher interest rate, because you will be seen as a riskier borrower who is more likely to not pay back the loan.
You obviously want to make sure your credit score is high as possible. If your score is lower than what you would like it to be, there are some ways that you can improve it quickly. To better understand how to improve your credit score, I will break down how credit scores are formulated. 35% of your score is based on paying your bills on time. 30% of your score is based on the amount of debt you owe. 15% of your score is based on your credit history. 15% of your score is based on the length of your credit history. Finally, 10% of your score is based on the mix of credit that you have.
The biggest factor of your credit score is your ability to pay your debts on time. In order to approve your credit score the most, you should first pay off any past due debts that you have. Take care of any bills you have that are late. This will have the biggest effect on your credit score. Next, you need on work on amount of debt that you owe. Work on paying down all the limits of your credit cards, and work on paying off any small loans. The lower your credit balance is, the better you look to lenders. Doing these things will improve 65% percent of your credit, giving you a huge bump in your score.
If you do not have any credit, you should open a credit card with a small limit. You can build your credit history by using the credit card for necessary items (such as groceries or gas for your car) and pay it off every month in full. This will show lenders that you can be responsible and handle paying off debt. However, do not go overboard with this and open up a lot of credit. Just open one account to start and pay it off on time, and you will be able to build up your score.
Debt
The amount of debt you have is a very important factor to determine how much mortgage you can qualify for. Debt can be any money that you borrow and have to pay back monthly, such as a car note, personal loan, credit cards, student loans, etc. The amount of debt you have affects your debt to equity ratio, which is what lenders use to decide how money they can lend you for a mortgage. If you can, work on paying off as much debt as possible.
Another tip is to consider paying off one thing in full at a time, instead of spreading out your money across all your debts. While you need to make your required monthly payments in order not to have any past due debt, paying off one debt completely, such as a credit card or a car note. The reason is because paying off something in full gets rid of the monthly payment for that debt, which allows you to qualify for more money.
Income
Last, but not least, your income will pay a huge role in how much mortgage you can afford. Lenders want to make sure that you have enough income to pay back the money they are lending you. They do this by looking at your debt to equity ratio. Your debt to equity ratio is your monthly debt divided by your gross monthly income. Keep in mind that this includes the debt that you plan on borrowing. In other words, the bank will only lend you money up until your debt to equity ratio reaches 43%. If your debt to equity ratio is above 43%, you will be seen as very risky to lenders because you have too much debt. Lenders like to see your debt to equity at 36% or less.
What can you do to increase the amount of mortgage you can qualify for? First, (and most obvious), having more income will allow you to qualify for more money. After that, focus on getting rid of as much monthly debt as possible. Monthly debt payments have a big effect on your debt to equity ratio. Just $100 per month can lower the amount you can qualify for by almost $20,000! If you can eliminate some of those payments, you can easily increase the amount of money you can qualify for.
Next, work on increasing your credit score. Your higher your credit score you have, the lower your interest rate will be. Having a lower interest rate allows lenders to loan you more money with a lower mortgage. As I mentioned before, the best ways to improve your credit are to make sure you pay off any past due debt, keeping the balance of your credits low, and to make sure you have some sort of credit history. Also, do not close any credit card accounts that you have. While paying them off is beneficial, closing the account can actually negatively affect your score! If you don’t want to risk using the credit card again, simply cut up the credit card. Having available credit with low balances shows lenders that you know how to responsibly handle debt.
Last, work on saving up your money. While it can be difficult to increase your overall income, it can be easier to start setting some money aside for the down payment. You will be able to qualify for higher prices if you can make a bigger down payment. Another benefit of having a larger down payment is that if the down payment is 20% or more of the overall price, you do not have to pay what is called private mortgage insurance, which can be an extra $100 a month on your mortgage! Even if you don’t have a large salary, you can make up for it by saving your money to make up the difference.
Please feel free to reach out to me here with any questions or comments. Thanks and have a great day!