Houses in Illinois: How Much Can I Afford?

It is extremely easy to be overwhelmed whenever you buy a house. After all, purchasing a home is a huge step and a big purchase. So naturally, you would want your home to be a blessing and not a heavy burden to pay. Which begs the question: How much home can I afford?

To determine how much you can afford for a house definitely requires some math. If you are anything like me, you probably prefer to insert a few numbers here and there and see what figures your calculator will spit out. But the truth is, calculating how expensive you can go when buying a house is much more than just a few numbers punched into a calculator, hoping that the amount is something you can afford. There are factors that are essential to take into consideration to determine how much you can afford.

In this blog, we will go over the factors we need to determine to see how much house can you afford. Rest assured, it is not that complicated. Here I simplified it into two easy and simple steps, wherein by the end of this blog, you will be able to determine:

• The maximum amount of loan the bank will lend you
• The conservative maximum you can afford (Dave Ramsey’s recommendation)
• The common factors and my recommendations

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Considering Your Specific Budget and Goals

This is simple, we will be going over the basics and rules of thumb. It is important to note that the amount you can afford should be determined by you and not anyone else. Never allow your lender, realtor, or anyone else even your family members determine your housing budget.

You are aware of your income and your spending lifestyle, so you are the only one who can calculate how much budget you can put into buying your house. Having peace of mind is so much better than nights spent sleepless. Banks will often lend you an amount more than most are comfortable with. Your housing budget should only be determined by the people ultimately responsible for the loan.

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Step #1: Determine Your Gross Monthly Income

The very first step is determining your gross monthly income or your before-tax income. The simplest way is by using you and your significant other’s yearly income and divide the amount by 12 for each month. If your income is fixed monthly, you can determine this using a pay stub.

Here are some examples:

Note that in order to qualify for a loan, you must document every type of income you have. Any other streams of income besides Form W-2 or your earned income that will help you qualify for a mortgage includes:

• Alimony
• Investment Income
• Disability Payments
• Social Security Pensions

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Step #2: Calculate Your Debt to Income (DTI) Ratio

After figuring out your monthly income, finding the debt to income ratio will be an easier process. The only thing you need is your list of monthly obligations or expenses.

The debt to income ratio basically compares your monthly income to your monthly debt. Borrowers that possess higher DTI ratios will experience a harder time qualifying for a loan and will probably be paying a higher interest rate.

To calculate your debt to income ratio, you must first add up all your monthly debt obligations including:

• Monthly rent or projected house payments
• Monthly child support payments or alimony
• Student loan payments
• Car payments
• Monthly credit card minimum payments
• Any other debts you might have

After listing all of this, you can then calculate your debt to income ratio by getting the sum of all your monthly payment obligations and divide it into your gross monthly income. Here is an example:

Example #1:

Rent Payment- $1,500 a month

Credit Card Minimum Payment- $160 a month

Student Loan- $240 month

Car Payment- $300 month

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Total Monthly Obligations- $2,200 a month / Gross Monthly Income- $8,750 = 0.25 or 25% DTI

After figuring out what your debt to income ratio is, everything will now be a breeze. Most lenders do not consider borrowers that have a DTI of over 43%. However, there are exemptions to the case, which is based on the strength of the borrower, loan type, and lender. Here are the maximum limits of a DTI based loan type:

• Conventional Loan- 45 to 50 % DTI
• FHA Loan- 50 to 57 % DTI
• USDA- 41 to 46 % DTI
• VA- 41 to 60 % DTI
• Jumbo Loans- 41 to 43 % DTI

When you are borrowing, it is best to pay off as much of your monthly obligations as possible. It is not suggested to run-up to the limit, so you are comfortable with your house as well as the payments.

If you purchase a house that you can not pay for, you will be what they call ‘house poor’. In this situation, you will not own your house, your house will own you. If the monthly mortgage payment is too tight, it will feel like a house with a big payment. It is tough living in a house you can’t consider as your home.

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What is A Conservative Mortgage Payment Ratio?

Not a lot of people have made quite an impact on American’s everyday lives and the financial industry like Dave Ramsey did. He has an ongoing radio show for almost 30 years talking about conservative finances. If you are not familiar with Dave Ramsey’s guidelines, here they are:

1. Save $1,000 for a starter emergency fund
2. Pay off all debt (except the house) by using the debt snowball.
3. Save 3-6 months expenses in a fully-funded emergency fund.
4. Invest 15% of the household income for retirement
5. Save for children’s college fund
6. Pay off home early
7. Build your wealth and give

Dave Ramsey’s Way for Home Mortgages

Here are guidelines for an extremely conservative approach:

• A fixed-rate conventional loan.
• A 15-year term.
• Monthly payment of no more than 25% of your monthly take-home pay.

Here is an example following this approach:

Example #1:

Yearly Income- $75,000

Tax Bracket- 22%

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Net Yearly Income- $58,500 / 12 months = $4,875

Net Monthly Income- $4,875 x 0.25 = $1, 218

Spending $1,200 on housing while maintaining a 15-year mortgage will make your price range at Chicagoland market $100,000- $150,000.

However, Dave Ramsey’s approach may be too extreme especially with the extremely high cost of living and housing. A lot of people struggle to find affordable housing using his way. However, I think his approach is more appropriate back in his day when the dollar was still linked to gold and the FED was not printing trillions of dollars, but times have changed.

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What is the Most Common DTI Ratio?

A lot of financial advisers agree with the idea that homeowners should avoid spending more than 28 % of their gross monthly income on housing and no more than 36 % on their total debt. This is referred to as the 28/36 rule, giving homeowners a quick basis on what they can afford each month. Another rule is 29/41, giving debtors extra slack on their obligations.

The 28/36 rule is often the best indicator of home affordability and peaceful nights, However, this rule does not particularly use home utilities and expenses, wherein 28% of total housing costs are a better metric that includes HOA fees, paid maintenance, and utilities. Here is an example:

Example #1:

Yearly Income- $75,000

Tax Bracket- 22%

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Net Yearly Income- $58,500 / 12 months = $4,875

Gross Monthly Income $6,250 x 0.28= $1,750 monthly mortgage or 35% of Net Monthly Income

What if DTI is too High?

If your DTI ratio is higher than 43 percent and you are in need of a loan, there are some things you can do and consider to help improve your chances of availing a home loan. Simple and straightforward, the factors are:

• Consider your budget
• Get a second opinion
• Increase your income
• Add a co-signer

However, if none of these factors are an option, here are some things you can do but this requires more work for you.

• Consider another Loan Program. Although you are likely to get the best rate in conventional, the guidelines are more strictly implemented. You can consider using an FHA Loan or a VA Loan since they have more forgiving DTI ratios.
• Paying Down the Rate. If you have cash reserves at your disposal and you can afford to invest in your home, you can lower the payment by paying down your mortgage interest rate.
• Restructuring Debt. There are times where you can refinance or pay down some of your loans to lower your DTI ratio. If you are capable of paying off some loans, I would suggest that you consult a lender for guidance. Remember that no debt is equal.

Here are all the basic pieces of information you need to know on how to determine how much house you can afford. I hope that this blog has helped you and provided you with insight on the topic.