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Are you thinking of buying a home? It’s often the largest personal investment you’ll make! But the amount you can afford to borrow is dependent on a variety of things, not only what the bank is willing to lend you. That’s why we’re going to break down everything you need to consider to figure out how much you can really afford.

Know What Lenders Look For

First, lenders will look at your gross income. Typically, this means your base salary plus any bonus income. It can also include part-time earnings, self-employment earnings, social security benefits, disability, alimony, and child support. Your gross income helps determine the Gross Debt Service Ratio (GDS). This is the percentage of your annual gross income that can go toward paying your monthly mortgage. The general rule of thumb is that the GDS ratio based on PITI should not exceed 28% of your gross income. 

Lenders will also calculate your Total Debt Service Ratio (TDS), which is the percentage of your gross income required to cover your debts. Your TDS ratio shouldn’t be greater than 36% of your gross income. To figure out your maximum monthly debt based on this ratio, multiply your gross income by 0.36 and divide it by 12. For instance, if you earn $200,000 annually, your maximum monthly debt services should not exceed $6,000—the lower the TDS ratio, the better.

Down Payment

How much you can afford to put down is used as a benchmark to ascertain your maximum affordability. Without factoring in income and debt levels, you can determine how much you can afford to spend using a simple calculation.

If your down payment is under $25,000, you can find your maximum purchase price using the following formula:

Down Payment / 5% = Maximum Affordability

If your down payment exceeds $25,001, you can find your maximum purchase price with this formula:

(Down Payment Amount – $25,000) / 10% + $500,000 = Maximum Affordability

For instance, if you have saved $50,000 for your down payment, the maximum home price you can afford is:

($50,000 – $25,000) / 10% + $500,000 = $750,000
A mortgage with a down payment of 20% or less is known as a high-ratio mortgage, and you’ll be required to purchase mortgage default insurance, commonly known as CMHC insurance.

Cash Requirement

Often home buyers forget to take closing costs into account when determining their mortgage affordability. However, on top of your down payment (including mortgage insurance if applicable), you should set aside 1.5% to 4% of your home’s selling price for closing costs, which are payable on closing day.

Credit Score

With your debt service ratios, down payment, and closing costs, mortgage lenders will also consider your credit score when approving you for a mortgage. If you have a low credit score, you can expect to pay a higher interest rate on the loan. If you know you’re going to be looking for a home in the future, it’s essential to work on your credit score now.

Before taking on this significant investment, it’s imperative to do the math. We hope this post helps you calculate the mortgage you can afford more easily. For more information about real estate and our communities, don’t forget to read the Falconcrest Homes’ blog