We have seen mortgage rates linger near 3% in recent weeks. But last week, the 30-year average fixed mortgage rate jumped to 3.17%. While many experts expect mortgage rates to rise towards the end of 2021, a weekly hike of 0.12% could worry potential borrowers. But rates are still considered low by historical standards and 1% lower than pre-pandemic levels.
There is no denying that interest rates have a direct impact on how much home buyers can afford. With a lower rate, payments are lower, allowing buyers to qualify for larger loans. But the rates are only part of the story. With the rise in home prices nationwide, buyers need a larger down payment to help offset monthly costs.
Existing homeowners are in a better position to take advantage of these low rates by refinancing their current mortgage. As home prices rise, homeowners can use the increased equity in their home to refinance with better rate terms, remove mortgage insurance, or refinance with cash. These options can free up monthly cash to invest more or pay off other high interest debt.
For potential buyers and homeowners looking to refinance, getting a low interest rate isn’t the only thing to focus on. What’s more important than a rate is your total debt ratio and how much of a mortgage payment you can comfortably afford. When buying or refinancing, these numbers will give you the best idea of how much home you can afford and how likely you are to be approved for a loan.
ABOUT LATEST MORTGAGE RATES
Last week’s average mortgage rate is based on mortgage rate information provided by national lenders to Bankrate.com, which, like NextAdvisor, is owned by Red Ventures.
How many houses can I afford?
Mortgage lenders will look at the debt-to-income ratio (DTI) before approving a loan. The DTI compares total monthly debt payments to monthly gross income. Your credit report contains most of the information a lender needs to determine your monthly debt payments. This can include car payments, mortgage payments, student loans, and minimum monthly credit card payments.
The total of these monthly debt payments is then divided by your monthly income to calculate your DTI using this formula:
Total debt / total income before tax = DTI%
Most conventional loans will allow a DTI of up to 50%. However, you might be limited to a lower DTI depending on the characteristics of your loan. Your credit history, credit rating, length of employment, loan-to-value ratio, and amount of assets you own are just a few things that can affect your maximum DTI allowed. Additionally, some lenders may have more stringent requirements regardless of other qualifying factors. If you are concerned that your DTI may cause problems in qualifying for a loan, you can request more information from the lender. And there are always other options if you can’t qualify for a conventional loan.
Why is DTI important?
It is important to pay attention to your DTI so that you know the amount of your debt compared to your income. When it comes to taking out a mortgage, borrowing the maximum amount a lender is willing to lend to you is not recommended. You don’t want to stretch your budget too much to account for other homeownership costs and contingencies. You’ll also want to factor in saving for retirement and contributing to an emergency fund after you’ve paid off your mortgage and tallied taxes and payroll deductions.
You can use the NextAdvisor mortgage calculator to determine your monthly mortgage payment amount based on the value of the home, the interest rate, and the length of the loan.
After determining a monthly payment that you’re comfortable with, here’s an example of how a lender can calculate DTI:
|Example of debt||Example of payment amount|
|Student loans||$ 200|
|Payment by credit card||$ 100|
|Car payment||$ 300|
|Total monthly payment for housing||$ 1,200|
|Everything above combined debt||$ 1,800|
|Total monthly income (before tax)||$ 4,800|
|DTI||Total debt $ 1,800 divided by total income before taxes $ 4,800 = 37.50% DTI|
Lenders will calculate your DTI by adding up all monthly student loan, credit card, car payment, and mortgage payments. In the example above, the debt payments total $ 1,800 per month, divided by the gross income before tax of $ 4,800 to get a final DTI of 37.50%.
However, it’s best to go further and look at your take-home pay (after tax). If we assume that 30% of the $ 4,800 in monthly income is spent on taxes and other payroll deductions, that means you would only see $ 3,360 of income deposited into your bank account. Subtracting the $ 1,800 monthly debt payments would leave you with $ 1,560.
Calculating your DTI can help you determine how much a lender might be willing to let you borrow. But that should only be one thing to consider when applying for a mortgage. It’s also essential to think about a comfortable monthly mortgage payment and the overall cost of homeownership.