We’ve seen mortgage rates linger close to 3% in recent weeks. But last week, the average 30-year fixed mortgage rate jumped up to 3.17%. While many experts predict a rise in mortgage rates towards the end of 2021, a weekly increase of 0.12% may concern 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 house buyers can afford. With a lower rate comes lower payments, allowing buyers to qualify for larger loans. But rates are only part of the story. With home prices increasing nationwide, buyers need a larger down payment to help offset monthly costs.
Existing homeowners are better positioned to take advantage of these low rates by refinancing their current mortgage. With rising home prices, homeowners are able to use the increased equity in their homes to refinance with better rate terms, remove mortgage insurance, or do a cash-out refinance. These options can free up monthly cash to invest more or pay down other high-interest debt.
For both potential buyers and homeowners looking to refinance, securing a low interest rate isn’t the only thing to focus on. What’s more important than a rate is your total debt-to-income ratio and how much of a mortgage payment you can comfortably afford. When purchasing or refinancing, these figures will give you the best idea of how much house you can afford and how likely you are to be approved for a loan.
ABOUT THE 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 Much House Can I Afford?
Mortgage lenders will look at debt-to-income ratio (DTI) before approving a loan. DTI compares total monthly debt payments to monthly gross income. Your credit report contains most of the information needed for a lender 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 pre-tax income = DTI%
Most conventional loans will allow for a DTI as high as 50%. However, you might be limited to a lower DTI depending on the characteristics of your loan. Your credit history, credit score, length of employment, loan-to-value ratio, and amount of assets you own are just several items that can impact the maximum allowable DTI. Also, some lenders may have stricter requirements regardless of the other qualifying factors. If you’re concerned that your DTI may cause issues with qualifying for a loan, you can ask the lender for more information. And there are always other options if you can’t qualify for a conventional loan.
Why Is DTI Important?
It’s important to pay attention to your DTI so you know how much debt you carry compared to your income. When it comes to taking on a mortgage, it’s not recommended to borrow the maximum amount a lender is willing to lend to you. You don’t want to stretch your budget too thin, to account for the other costs of homeownership and the unexpected. You’ll want to also account for saving for retirement and contributing to an emergency fund after paying your mortgage and accounting for taxes and payroll deduction.
After you figure out a monthly payment you are comfortable with, here is an example of how a lender may calculate DTI:
|Debt Example||Payment Amount Example|
|Credit Card Payment||$100|
|Total Monthly Housing Payment||$1,200|
|All Above Debt Combined||$1,800|
|Total Monthly Income (pre-tax)||$4,800|
|DTI||Total debt $1,800 divided by total pre-tax income $4,800 = 37.50% DTI|
Lenders will calculate your DTI by adding up all monthly payments on the student loans, credit cards, car payment, and mortgage. In the example above, the debt payments total $1,800 per month, divided by the gross pre-tax income of $4,800 to get a final DTI of 37.50%.
However, it’s best to go one step further and look at your net (post-tax) take-home pay. If we assume that 30% of the $4,800 monthly income goes towards taxes and other payroll deductions, it means you would only see $3,360 of income deposited to your bank account. Subtracting the $1,800 in monthly debt payments would leave you with $1,560.
Calculating your DTI can help you figure out how much a lender might be willing to let you borrow. But this should only be one thing you consider when applying for a mortgage loan. It’s essential to also think about a comfortable monthly mortgage payment and the overall cost of homeownership.