Here’s how to figure out how much income you’ll need to buy a house.
Understanding Debt-to-Income Ratios
Your debt-to-income (DTI) ratio is the amount of debt you have in relation to the amount of money you earn. For example, if your gross monthly income is $5,000 and you currently have debt obligations that total $2,000, you’d calculate it like this: $2,000 / $5,000 = 40% Your DTI is 40%, which means 40% of your income currently goes toward debt payments. Mortgage loan studies have shown that borrowers with higher DTIs tend to have more trouble making their mortgage payments. Lenders will therefore calculate your DTI to determine how much house you can comfortably afford when you’re looking into buying a house. But they won’t look at just your overall DTI. Lenders also look at your ratio of housing-related debt to your gross income. Your housing-related debt-to-income ratio would look like this if you pay $1,650 per month for all your housing-related expenses and your gross monthly income is $5,000: $1,650 / $5,000 = 33%
DTI Requirements for Mortgages
The amount of income you’ll need depends on your loan program, loan term, interest rate, and down payment. Most mortgage lenders require you to have a total DTI of less than 45%, and a housing-related DTI of less than 36%. FHA-backed loans require that your total housing debt must be 31% or less of your gross income. Your total debt can’t exceed 43% of your total gross income. Fannie Mae, a government-sponsored enterprise (GSE), has a maximum total DTI ratio of 36%. Fannie Mae will allow total DTIs up to 45% if a borrower meets certain other credit score and reserve requirements. Freddie Mac, another GSE that finances home loans, has a maximum housing expense ratio of 28% and a maximum DTI of 36%, up to 45% if the borrower meets credit score and other requirements.
How Much Money Do You Need To Buy a Home?
Let’s look at couple examples of how much income you may be required to earn per year and per month in order to buy a house. We’ll look at FHA loans and loans from Freddie Mac. Using our mortgage calculator to figure out the estimated monthly payments, here’s what it may look like if you’re buying a home that costs $374,900: Your housing expense ratio might be capped at 28% if you go with a conventional loan financed by Freddie Mac and you put 3% down, sign a 30-year term, and get a 6% interest rate. You would need a gross income of $9,725 per month and $116,700 per year to buy the same $374,900 house. Let’s look at one more hypothetical situation. Let’s say you get a 30-year conventional mortgage from a different lender. You put 20% down on the $374,900 house, have an interest rate of 6%, and pay no PMI. Your monthly mortgage payment, taxes, and home insurance totals $2,126. With a maximum housing DTI of 36%, you’d need a gross income of $5,906 per month and $70,867 per year. The lower DTI requirements result in a higher income requirement, and the higher your down payment, the lower the income requirement.
The Effect of Your Down Payment
The amount of your down payment will affect how much gross income you need because it will either increase or decrease the amount you’re borrowing and thus your monthly payments. The FHA program requires that you put down at least 3.5%, but you’ll have to put down 10% if your credit score is between 500 and 579. You’ll have to put down at least 20% to avoid paying PMI on a conventional loan. Here’s a look at what you can expect to put down on a $374,900 home with each of the down payment options:
FHA 3.5% down payment: $13,121.50FHA 10% down payment: $37,490Conventional 20% down payment: $74,980
Lowering Your Debt or Increasing Your Income When Buying a Home
If you already have a lot of debt obligations per month, such as a personal loan, a car loan, or credit card debt, see if you can pay those down to make room in your budget for a new home loan. For example, if your gross income per month is $5,000, but you have a monthly personal loan payment of $350, a monthly car loan payment of $250, and monthly credit card debt of $1,000, your current DTI is 32%. By eliminating the credit card debt, your DTI would drop to 12%. This gives you more room in your budget to buy a house and take on new debt. If your individual income is not enough to buy a house, you could look into buying a home with a partner, family member, or friend. Your monthly gross income would be the total of both of your incomes together. This could help increase the amount of home you could afford to buy. For example, if you earn $5,000 per month and your spouse earned $5,000 per month, then you have a total monthly income of $10,000 and would be able to take advantage of any of the loan programs in our examples above. After crunching your own DTI numbers to see how much income you need to buy a house, shop around for the right mortgage lender, interest rate, and program that fits your financial situation.
