By Pablo Gibson, financial writer for Safe Financing.
Everyone dreams of owning a house of their own at some point of time in life. In order to fulfill this dream, people take out mortgage loans to purchase a house. These loans come at varying rate of interest as well as terms of repayment. There are times when home buyers jump into a decision to take out a mortgage loan without asking themselves ‘how much house can I afford’.
So, it is very important that every home-buyer is well conversant about his capacity to service a mortgage loan efficiently.
Factors that influence mortgage affordability
Here are the factors that will determine how much a person can afford to manage a mortgage loan competently:
- Debt liabilities – The amount of debt liabilities is a crucial factor that reveals the capacity of a person to manage timely loan payments. In order to arrive at a conclusion regarding a person’s mortgage affordability, lenders make use of debt-to-income ratio. It is a ratio that reveals how much of the monthly salary earned by an individual is spent in making the debt payments. This is known as back-end ratio too. Ideally, debt-to-income ratio must not be excessive of 36% of a person’s monthly salary.
- Private mortgage insurance (PMI) – People, who can’t make huge down payments (for example 20% or more), then they will have to pay for private mortgage insurance along with the monthly loan payments. Federal mortgage loans like the FHA or VA, however, have very low down payments.
- Mortgage interest rate – The rate of interest levied on mortgage loans is another key factor in deciding an individual’s mortgage servicing capacity. Difference in mortgage rates will greatly influence the monthly payment amount. So, it is best to have several mortgage quotes and weigh all the pros and cons of a particular type of mortgage loan before signing the loan papers.
- Loan processing charges – These are also known as closing costs. It is the expense incurred by the lenders as well as the borrowers to successfully close a mortgage deal. Attorney fees, mortgage underwriter’s fees, market research charges, legal paper work costs, home appraisal costs and so on are considered as closing costs. As a result, a typical mortgage loan may have a closing cost of around 2-7% of the selling price of a home.
Last but not the least, a person’s monthly mortgage costs must not exceed beyond 28% of the entire disposable income. This is known as front-end ratio, which is of utmost importance to the lenders in deciding how much mortgage one can afford.