True affordability can difficult to understand. Especially considering all of the monthly subscriptions, utilities, insurance, and other monthly recurring expenses that are not reported by creditors such as monthly cell phone expense, childcare expenses, etc... Just as important as accurately accounting for total monthly debt, take-home income is needed to qualify and really understand how much you can afford.
Debt to Income (DTI) is the primary factor that lenders use to determine affordability.
Total Monthly Recurring Debt / Total Monthly Gross Income
Home loan applications with DTI of over 41% may have additional requirements of the lender to compensate for having a DTI over 41%, but it is certainly possible to have a home loan with a DTI over 41%.
Variables That Affect Affordability
There can be a significant difference between how a lender calculates your DTI and how you may feel more comfortable calculating your DTI for true affordability.
Calculating Debt
Lenders typically will count only the monthly recurring expenses that are reported on your credit as well as any alimony, child support, or other major debts that are owed that will require a monthly payment such as IRS debt.
While these are the only debts that the lender may need to calculate your DTI, it's important to remember that YOU will be the homeowner and it will be you who will be legally obligated to make your future monthly mortgage payment on-time. Because if this, I always advise my clients to calculate ALL of their monthly recurring debts to include any online subscription fees, i.e. Netflix, Spotify, HBO, cell phone, as well as all utilities, auto insurance, daycare expenses, etc...
Not doing this could result qualifying for and buying the home of your dreams, but later discovering that it feels like it costs a lot more to live there than you had originally planned because you didn't initially calculate all monthly expenses for your affordability.
Calculating Income
For conventional home loans, lenders will use your GROSS income to calculate your DTI. For example, if your annual salary is $65,000 per year and your total monthly debt for credit cards and auto payments is $895, then the lender will estimate your new mortgage payment (let's assume $1,200) and they will conclude that your DTI is as follows:
Total Monthly Debt: $2,095 / Total Monthly Income: $5,416 = 39% (No idea how much $$$ is left over)
While this is technically the correct way to calculate DTI, this does not account for all of your monthly debt. It is also account for more income than what you actually bring home (net income).
For a more accurate DTI calculation, let's include your monthly subscriptions, utilities, insurance, etc... so we have all debt accounted for. Let's also subtract your taxes, 401k contributions, and healthcare expenses from your gross income so we can calculate your DTI with the actual amount of money you bring home each month.
Total Monthly Debt: $2,650 / Total Monthly Income: $4,442 = 60% ($1,792 left over to live on)
The difference between DTI and affordability is critical. While the lender uses DTI to qualify a homebuyer using a percentage, having a trusted lender to help you calculate your affordability, using real dollars so you understand how much money you will truly have left over at the end of the month after using your net income to pay ALL debts.
Being mindful of the difference in calculating your affordability versus DTI can set you up for a joyful homeownership because you will have a better understanding of how much money you actually have to live off of. No one wants to be house-poor.
Get started by calculating your affordability by accessing my free calculator.
Buying your first home is an exciting chapter in life. It may also be the the largest purchase of your life and this can make it scary at times. That's why we are available to help guide homebuyers along the way. Please don't hesitate to give us a call at 1-573-239-9631 or start your quote today.
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Terry Roberts is a U.S. Marine Corps Veteran and specializes in residential mortgages, including new construction, conventional, FHA, and VA home loans. He has helped more than 10,000 clients start the homebuying process across America.
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