Before you embark on shopping for a new home or considering a custom home design and build, it’s crucial to address a fundamental question: How much home can you realistically afford? Understanding this aspect provides the foundation to kickstart your home search and identify a suitable home that aligns with both your needs and budget.
Here’s a comprehensive guide to determining the home affordability aspect from our esteemed custom home builder in GA.
Preparation: Assess Your Debt-to-Income Ratio
When engaging with a mortgage lender, one of their initial steps is evaluating your debt-to-income ratio (DTI). This percentage serves as a benchmark for the lender to gauge your financial capacity to manage loan repayments. To calculate this figure, the lender compares your gross monthly income against two categories of debt: (1) essential housing-related expenses and (2) non-housing expenditures (credit cards, auto loans, student loans, etc.).
If your DTI exceeds an acceptable threshold, your application may face rejection due to concerns about your ability to fulfill mortgage payments. For most lenders, a maximum DTI ratio of 41 percent is typical.
Assess Your Housing Ratio
Contemplate the portion of your monthly income that you can allocate to housing expenses and the corresponding percentage of your income. Housing expenses encompass elements such as principal, interest, property taxes, insurance, any HOA fees, mandatory flood insurance (if applicable), and other homeownership costs. While lenders generally prefer a housing ratio of 30 percent or less, a slightly higher percentage may be acceptable as long as your overall DTI ratio remains low.
Impact of Loan Type on Down Payment
Four primary mortgage loan types are available: Conventional mortgages, FHA mortgages, USDA mortgages, and VA mortgages.
Conventional mortgages, sold to Fannie Mae or Freddie Mac, often require substantial down payments of 20 percent or more. On the other hand, FHA mortgages can be obtained with as little as 3.5 percent down for individuals with credit scores above 580 (or 10 percent for those with scores below 580). USDA and VA loans may feature down payments as low as zero dollars in certain cases. However, VA loans necessitate applicants to be active-duty or retired military personnel.
Don’t Overlook Closing Costs
Depending on your new home’s location, closing costs can comprise 2 to 5 percent of your overall home purchase transaction. Notably, both Fannie Mae and Freddie Mac permit builders or home sellers to contribute up to 3 percent of the home’s price to mitigate your closing costs. For FHA loans, the builder or seller can contribute anywhere from 3 to 6 percent.