When you’re buying a home, what you can afford depends on a number of factors – chief among them your credit scores. If you have low credit scores you may qualify for a poor-credit home loan, but you will pay a higher interest rate and may be required to have a larger down payment.
People with credit scores of at least 500 may qualify for a Federal Housing Administration (FHA) mortgage.
Before you do anything, get your scores and reports from the three national credit bureaus – Experian, Equifax and TransUnion – so you know where you stand. Credit scores from these agencies typically range from 300 to 850.
Once you know your scores, take these steps to figure out what you can afford:
Calculate the standard amount dedicated to housing. Lenders typically don’t want you spending more than 25 to 33 percent of your gross monthly income on housing (and don’t forget, this includes not only the mortgage payment but also insurance, maintenance and taxes).
What’s the most you can afford to pay? Review your bank statements and other records and calculate your total monthly expenses. Once you deduct your total monthly expenses from your monthly take-home pay, how much is left? That’s the most you can pay for housing regardless of what the calculation in #1 above yields.
Understand your debt-to-income (DTI) ratio. This is the sum of all your monthly debt payments (credit cards, auto loan, mortgage, etc.), divided by your gross monthly income. Generally, it should fall between 28 and 36 percent. This means that if you have a lot of credit card debt, then your mortgage as a percentage of your monthly income cannot be as high as 33 percent as indicated in #1 above, because your total DTI would then be above 36 percent.
Making the calculations above will allow you to determine how big a mortgage payment you can afford and if it falls within the ranges lenders are looking for. Your scores will determine the rates you will be offered.
Finally, there is the down payment. Even if you qualify using the calculations above, you will still need to make a down payment, which can be as high as 20 percent.
If you don’t have great credit, consider an FHA loan. FHA mortgages can come with a down payment of just 3.5 percent, if your credit scores are at least 580.
Overall, your credit scores are key factors in determining what your interest rate will be, which impacts what you can afford. Start by getting your credit scores and reports from all three bureaus in seconds from FreeScore360, powered by ScoreSense®. ScoreSense also monitors your credit and alerts you to changes on your credit profile, helping you to protect your identity and your future credit standing.