How Much House Can You Afford?

When determining how much home you can buy using a loan, lenders look at your debt-to-income (DTI) ratio.

How to Calculate DTI

They do this by dividing all your mandatory monthly payments by your total income. For example, let's say your project monthly mortgage payments, car lease, student loan, and child support payments add up to $7,000 a month.

And your total income every month is $10,000.

Your DTI is $7,000 / $10,000 or 70%.

Different Loan Products Have Different DTI Requirements

For example, a conventional loan has a max DTI of 36%. A VA loan has a max DTI of 41%. And an FHA loan has a max DTI of 43% but in certain circumstances can be as high as 50%.

What is Considered Debt

There are also certain rules around what is considered mandatory monthly payments. For example, WiFi or cellphone plans? Not considered mandatory and doesn't count towards your debt. Neither is food. And car payments? That depends on how many months you have left before you pay it off. Less than 10? Doesn't count. More than 10? It counts.

Rent or an existing mortgage can be considered a mandatory monthly payment, but only if you don't plan on giving up your current residence. This applies to investors and those purchasing a second home.

What to do if DTI is too High?

Mathematically, there are only two ways to decrease your DTI: lower your debt payments or increase your income.

Practically, there are several ways to lower your debt and increase your income.

One way to lower your debt is to pay off any existing debt that counts towards your DTI in full. Another way to do it is to restructure your debt by consolidating it into a single longer term loan. This is useful because only monthly payments count towards your DTI, not the full loan amount. So if you have 10+ months left on your car payments, you may be better off refinancing it into a 5 year loan to lower your monthly obligations than paying it off all at once. Of course, you can refinance again or make higher monthly payments towards the principal on your car after the house closes.

Increasing income is similar flexible. Purchasing a multifamily or a house with one or more guest houses (ADUs) allows you to count existing or estimated rental income towards your own income, increasing it and lowering your DTI.

Conclusion

In conclusion, lenders try and determine your ability to repay the loan based on weighing your current debts against your income. There are many strategies an experienced lender can suggest to help lower your DTI so that you can qualify for a loan to purchase that home you've been eyeing.

For a free calculator to figure out how much home you can afford, click here.