Buying a home is substantial part of the American Dream, so it's highly likely that when you picture your future, homeownership is a large part of it. Before you make the transition from renter to owner, though, it's essential to know where you stand financially so that you know what you can afford.
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The first thing to consider when determining how much house you can afford is your personal monthly income. This includes your annual salary, freelance income, lottery winnings, alimony payments, assets, and any other money you have coming in that can be documented or shows up on your tax return. Any source of income that cannot be documented will not help you qualify for a loan.
Your debt and credit history
Your monthly debt is a key factor that lenders consider when determining if you qualify for a loan. When you configure your debt, combine all of your (and your co-borrower's) debts, including alimony and child support payments, credit card payments, student loans, other personal loans, and mortgages (other than the one you're applying for). For revolving debt, such as a credit card, you only need to factor in the minimum amount due. Also, it's not necessary to include anything you think you'll be able to pay off in six months.
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Housing payment-to-income ratio
Also known as the front-end ratio, the housing payment-to-income ratio shows how much of your gross income would go toward your mortgage payment, including principal, interest, real estate taxes and homeowners insurance. Typically, your front-end ratio should not exceed 28 percent of your gross monthly income. To determine this number, multiply your annual income by 0.28 and then divide by 12 (months).
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Your debt-to-income ratio, sometimes referred to as the back-end ratio, is equal to your total minimum monthly debt divided by your gross monthly income. Lenders don't want you to take out a loan that you can't afford, so they look at it like this: Your monthly housing expense and your monthly debt combined should not exceed 36 percent of your gross monthly income.
Online home affordability calculators
Although it's a good idea to educate yourself on how lenders determine whether or not you qualify for a loan, there are plenty of online calculators that will automatically configure these numbers for you.
Sarah Kaufman is the editor-in-chief of the Manilla Blog at Manilla.com, the leading, free and secure service that helps consumers to simplify and organize their daily lives in one place using Manilla.com or the top-rated iOS and Android mobile apps. With just one password, customers can manage their finances, utilities, daily deals, magazine and Netflix subscriptions, travel and rewards programs, and more. Sarah is a regular contributor to Yahoo! Finance, Good Housekeeping, Woman's Day, The Jane Dough, The Motley Fool and other major sites. For more financial tracking and budgeting tips, visit Manilla.com.