When we apply for a mortgage we should always have some idea as to how much we can afford to borrow, and our capacity to repay the mortgage. Knowing how much we can afford is vitally important because nobody would like to lose their house or investment property to foreclosure. When we ask ourselves the question of ‘how much can I borrow for a mortgage’ it will be highly dependant on two major factors:
1.) The interest rate charged on the mortgage
2.) The amortization, or length, of the mortgage.
When it comes to lenders or banks deciding upon the amount and rate of the mortgage loan, they will certainly look into the financial background of the borrower.
Lenders are typically looking to satisfy themselves of the Three C’s of credit – Including the capacity to repay the loan, along with the credit history and the character of the individual. These factors can be determined initially by looking at the credit score, and secondly by calculating several ratios before the determination of how much credit they can grant to the borrower.
The Real Cost of A Mortgage
When one decides to buy a house, there are several payments that must be paid on time in addition to the actual mortgage payment. These other payments should always be included when we ask ourselves the question ‘How much can I borrow for a mortgage’?
Such additional payments consist of home owners insurance, property tax and home owners association fees. When these are all added to the mortgage payment, they comprise a more realistic cost of home ownership. In addition, add this to your other anticipated monthly expenses and this is one of the ways to estimate how much you can really afford when you apply for a mortgage.
Private Mortgage Insurance – PMI
This might be another expense that could alter how much mortgage we can afford. Private mortgage insurance, also known as PMI; is an additional cost that must be added if you are not able to afford 20% of the homes price paid as a down payment. In such a case, you will need to purchase private mortgage insurance in order to protect the bank’s investment in your high ratio mortgage.
The front and ratio is the comparison between the monthly mortgage cost-which includes insurance, real estate taxes, private monthly insurance with your total monthly income. Generally mortgage costs are given to make up between 26% to 29% of your monthly income, in this case your monthly maximum repayment amount would be $840. This is another analysis you can use in answering the How much I can borrow for a mortgage question.
When your total income is compared with your total debt payments, this is called back end ratio. This, more comprehensive, ratio includes credit card debt and college loans, and any other debt you have. It can make a total of up to 33 to 40% of your income.
For example, if your bank sets 35% as the limit, and you have a monthly income of $3000. In this case your total debt paid in a month would be $1,050. If you pay $400 as a monthly student loan, you would then have a maximum of $650 left from your income which can be used to repay the mortgage loan.
If you have a good credit score, the banks may increase the limit of the above ratio calculations because your history of repayment cements the bank’s faith in your credibility. Once the ration is determined, all the aforementioned characteristics and calculations help both the borrower and lender in deciding how much credit is really affordable for the borrow.
As you can see, answering the question ‘How much can I borrow for a mortgage’ is not as easy as we might think. There are many variables that lenders take into consideration and we must fully understand those variables in order to determine how much mortgage we can really afford. It’s just not as easy as some online mortgage calculators would have you believe!
For more information on Mortgages, check out my Mortgage Survival Guide For the First Time Homebuyer!