When you’re ready to buy a home, determining what you can afford is even more important than what a lender says you qualify for. Granted, you can’t get a loan for more than a lender offers, but typically, your affordability is lower than your qualification. Once you have established that, it’s time to get pre-approved. Here’s what you need to know.
How lenders qualify borrowers
Lenders tend to focus on three main points when qualifying a prospective buyer before lending them money to buy a home:
- Credit score
- Down payment
- Debt-to-income ratio
Your credit score factors how you’ve paid your bills in the past and predicts how you’ll pay them in the future. The higher the score, the better your credit.
Lenders also want a down payment from the prospective borrower. Depending upon the loan type, the required down payment can be as little as 3% to 20%.
With a debt-to-income ratio, lenders look at your hourly or salaried income, give some benefits for overtime, bonus, commission, etc., and divide that into your debt. They define debt as the proposed monthly housing payment and any minimum monthly payments on your credit report (student loans, credit cards, car payments, etc.). That produces a percentage they like to keep in the mid to low 40s. Lenders use this debt-to-income ratio to determine qualification, which is good. But does that tell us anything about affordability?
Focus on your budget and what you can afford
Often, we define qualification as what a lender says you can do, while affordability is what you say you can do. We need to qualify for the loan in the eyes of a lender, but in many cases, based on guidelines, lenders will give you a considerably higher loan than you can genuinely afford.
So how do we go about defining affordability? Best to start with a budget. Ask yourself: What do you pay today for housing? How much are you saving (outside of retirement savings)? What monthly discretionary spending can you reduce or eliminate?
I’d invite you to reach out to us to start a discussion on your situation to see what you can truly afford.
