Getting a mortgage to buy a house is often the biggest investment most people make on their own. How much you can finance depends on a lot of things, not just how much a bank will give you. You need to look at not only your finances but also your likes and dislikes and what’s most important to you. Here are all the things you need to think about to figure out how to refinance your mortgage rule of thumb according to Dave Ramsey’s mortgage and the percentage of income to invest to own your dream house.
Mortgage Rule of Thumb
A common rule of thumb in the real estate market is that lenders figure out how much a person can borrow based on their debt-to-income ratio. In other words, a person’s debt-to-income ratio is their total debts divided by their gross monthly or annual income.
Most of the time, lenders will consider giving loans to people if the amount of the loan is at least 28% of their gross income. The “mortgage rules of thumb,” which include rules like “rule 32 percent” and “rule 40 percent,” are a group of other rules.
If the amount you want to borrow is more than any of these limits, your application will probably be turned down. If you know these criteria, you can use math to determine if you can acquire the loan you want. You will waste time and energy if you wait for the bank to tell you the same thing. Doing this will save you time and energy.
How Does the Refinance Mortgage Rule of Thumb Work?
The 1 percent refinance mortgage rule of thumb says that you should think about refinancing your home if you could get an interest rate that is at least one percentage point lower than your current rate. The new rate is better if it is lower.
“If you have a $500,000 loan, you’ll save about $280 a month, or $3,360 a year, if the rate goes down by 1 percentage point,” Melissa Cohn, an executive mortgage banker at William Raveis Mortgage, told The Balance in an email.
How Many Mortgages Can I Afford?
Most homebuyers can afford a mortgage that’s two to two-and-a-half times their annual salary. Using this formula, a person who makes $100,000 a year can only afford a mortgage of $200,000 to $250,000. But this calculation is just a rough estimate.”
In the end, there are a few more things you need to think about when choosing a property. First, know what your creditor believes you can afford (and how it arrived at that estimation). Second, you need to think about yourself and decide what kind of home you are willing to live in if you plan to stay in the house for a long time, as well as what other things you are willing to give up (or not) in order to live in your home.
Why Does the 1% Rule for Refinance Mortgage Rule of Thumb Generally Work?
Using 1% as a rule of thumb to decide when to refinance a mortgage makes sense because you could save several thousand dollars every year. Using the same example as above, Cohn said, “If you have a conforming loan and closing costs are around $6,000, it will take just under two years to break even and really start saving money with the refinancing.”
Let’s say you’re thinking of refinancing a $200,000 loan with a 6% interest rate and a $1,199 monthly payment. Here’s how much you’d save if you refinanced to a lower rate by 0.5 or 1 percentage point. But not all of those savings will go into your pocket. You’d have to take out the costs of refinancing, closing, and paying off the loan early. Freddie Mac says that the average closing cost is about $5,000. Consider these charges before refinancing at a rate that is less than one percentage point lower than your current rate.
1% Refinance Mortgage Rule of thumb vs. Break-Even Point Rule
The 1 percent refinancing guideline is good, but you should also consider the break-even threshold rule. This rule of thumb is based on closing expenses and savings, Cohn said. After you’ve paid off your refinancing fees, this is when you’ll start to save money. So, when you decide to refinance, you should think about how long you plan to live in the house.
Let’s go back to the example we used above of lowering the rate on a $200,000 mortgage from 6% to 5%. You’d save $125 a month, which, after taxes, would be $90. But let’s say your new mortgage costs you $2,500 in fees and closing costs. If you split your spending ($2,500) by your monthly savings ($91), it will take 28 months to break even. If you plan to move soon, refinancing may not be worth it.
What Percentage Of Income Should Go Toward A Monthly Mortgage Rule of Thumb Payment?
Since every homeowner’s circumstances are different, there is no one-size-fits-all rule according to how much you should pay each month on your mortgage. Still, specialists have some tips to help you make sure you don’t end up spending too much on housing.
#1. The 28% Rule For Mortgage Payments
The “28 percent rule” says that your mortgage payment, including property taxes and insurance, shouldn’t cost more than 28 percent of your monthly gross income. This is often called a safe mortgage-to-income ratio or a good general rule of thumb for mortgage payments. Gross income is what you earn before taxes, debt payments, and other obligations. Lenders usually look at your gross income to figure out how much of a mortgage loan you can afford.
It’s not hard to figure out how to use the 28 percent rule. Let’s say that your household has a monthly gross income of $5,000. If you multiply your gross monthly income by.28, you can get a rough idea of how much you can spend on your mortgage each month. In this case, if you follow the 28 percent rule, you shouldn’t spend more than $1,400 a month on your mortgage payment.
#2. 28/36 Rule
You know what the 28 percent rule is, but you don’t know what the 28/36 rule is. As we’ve already said, the 28 percent rule says that, as a homeowner, you shouldn’t spend more than 28 percent of your monthly income on your mortgage rule of thumb payment. Then, you shouldn’t have spent more than 36% of your income on your other debt (house debt, car loans, credit cards, etc.). This is another helpful rule of thumb for spending inside your budget.
What Is My Debt-To-Income Ratio (DTI)?
When deciding how much of a loan you can afford, lenders don’t just look at your gross income. Your debt-to-income ratio is also a very important factor.
Your debt-to-income ratio informs lenders how much of your monthly income goes toward debt and other obligations. Lenders look at your DTI ratio to figure out how much you can pay each month on your mortgage. If your DTI ratio is high, it means that you are a riskier candidate for a mortgage because you have less money left over after paying your bills. If you lose your work or have other financial troubles, you may not be able to pay your mortgage.
How Many Mortgages Can I Afford?
Borrowers need to figure out for themselves how much they can really pay for a house payment. Even though the Rule of 28 is a good place to start, it’s better to make a realistic budget for your future life as a homeowner.
When making a budget for the future, start with your monthly bills. A realistic budget should include all of the things you can’t live without in this day and age. Think about how much your cell phone and gym membership cost, as well as how much it costs you to buy groceries and gas.
Your new real estate venture will add to your current costs. Property taxes and regular home repairs are two costs that people often forget about.
If you take the time to make a realistic budget before you move in, you can avoid being “house poor.” Basically, the term “house poor” refers to borrowers who can make their mortgage payments but have to make big cuts in other areas of their budget to do so. The borrower may have a great house but not enough money to repair or furnish it. It’s crucial to have a decent home and enough money to smell the roses.
Dave Ramsey Housing Guidelines vs. 28/36 Mortgage Rule of Thumb
The 28/36 rule is the standard debt-to-income ratio that is used in the mortgage business. This means that your total monthly debt payments shouldn’t be more than 36% of your income before taxes, and no more than 28% of your income should go toward housing.
The most important thing to take away from this is the Dave Ramsey mortgage rule of thumb is designed to help you get rich. With a lower mortgage payment, you might avoid credit card debt and save more money. Not only will your monthly payment be less, but you will also have to pay for 15 years less.
On the other hand, the mortgage industry’s rules are set up to help them make as much money as possible.
What are Closing Costs, and How High are They?
The many expenses that must be paid for in order for you to legally acquire a home are referred to collectively as “closing fees.” You should budget anywhere from three percent to five percent of the total price of your house for the closing costs, which can include things like title fees, an appraisal, taxes, and recording fees. 5
Can I Get a Mortgage with a 50% DTI?
It is feasible, but not guaranteed, that you will be able to locate a mortgage lender who will work with you even if your DTI is as high as 50%. If the borrower has six months’ worth of payments saved up in addition to other qualifying conditions, the government-sponsored mortgage finance company Fannie Mae will approve a DTI of “over 45%” on a case-by-case basis. This is one of Fannie Mae’s flexible lending guidelines.
What is the “Ability to Repay” Rule?
Mortgage lenders have a responsibility to perform what is known as “due diligence” in order to ensure that borrowers will be able to pay back their loans. For instance, if the interest rate on a mortgage is going to be raised in a few years, the lender is responsible for ensuring that the mortgage can still be paid even with the higher rate.
How Much of a Mortgage Can I Afford Based on My Salary?
It’s common practice to use a rule of thumb to estimate how much of a mortgage payment you’ll be able to afford based on your income. For instance, according to the recommendations of certain industry professionals, you shouldn’t spend more than two to two and a half times your yearly gross income on a mortgage (thus, if your annual salary is $60,000, the size of your mortgage should be no more than $150,000). According to some other sets of guidelines, you shouldn’t spend more than 28-29% of your monthly gross income on housing expenses.
What Does It Mean to Be House Poor?
A person is said to be house poor when the majority of their wealth is invested in their home and a significant portion of their income is used to pay off their mortgage and other costs associated with it. An illustration of this would be if you had $100,000 in savings and utilized the entire amount to finance a home that cost $500,000 and had a mortgage payment of $2,500 per month, despite the fact that your monthly net income was $3,000.
If things take a turn for the worst, this kind of arrangement can give the impression that the economy is doing well, but it can lead to foreclosure very rapidly.
How Much Debt Can I Already Have and Still Get a Mortgage?
Your income, and more specifically your debt-to-income (DTI) ratio, will determine the maximum amount of debt you are allowed to carry at any given time. When applying for a mortgage, the rule of thumb is to have a DTI that is less than or equal to 30%, and once the mortgage has been paid off, it shouldn’t be higher than 43%.
Dave Ramsey Mortgage Rule vs. 50/30/20 Budget
The 50/30/20 budget is one of my favorite ways to make a budget. This budget says that you should spend 50% of your income on needs, 30% on wants, and 20% on savings.
I think this method of budgeting is most useful when it’s used to help people make big financial decisions by making a budget for their future.
I set aside half of your budget for “needs,” which includes housing costs and home maintenance. But so do things like food, transportation, and insurance, which have to be paid every month.
If it turns out that 65 percent of your hypothetical mortgage rule of thumb income goes to needs, that only leaves 35 percent for wants and savings. In other words, buying a bigger house means giving up things you want (like travel and entertainment) or money you want to save (e.g., you may have to delay retirement).
You won’t necessarily be “house poor,” but you will have to give up other financial goals every month to make the mortgage payment.
What Do Lenders Generally Require?
PITI, which stands for principal, interest, taxes, and insurance, refers to your monthly housing expenses. Lenders typically ask that these costs make up less than or are equivalent to 25% to 28% of your monthly gross income. This is referred to by financiers as the “front-end” ratio. To put it another way, if your monthly gross income is $10,000 or if your yearly gross income is $120,000, your mortgage payment should be no more than $2,800.
$10,000 X 28% = $2,800 – maximum monthly housing costs
Lenders typically require that the combined monthly cost of housing expenditures and long-term debt be lower than or equal to 33 or 36 percent of the borrower’s total monthly income. This is referred to by financiers as the “back-end ratio.” To put it another way, if your monthly gross income is $10,000, you shouldn’t have more than $3,600 in total long-term debt, including your mortgage payment of $2,800 and any other such payments.
$10,000 X 36% = $3,600 – maximum total debt
If your debt-to-income ratio is higher than the ratios listed below, you should discuss your options with your lender.
Dave Ramsey Mortgage Rule of Thumb vs. My Own Thoughts
Most people’s homes are the most expensive thing they’ll ever buy. Since most homeowners borrow money, there is also leverage, which is just as important.
According to Dave Ramsey’s mortgage rule of thumb, many people acquire too many residences for these two reasons. In order to do so, they often have to give up other, often more important, financial goals.
Still, I can think of some situations where I wouldn’t strictly follow Ramsey’s rules of a 20% down payment (or at least 10% after two years of saving hard) and a 15-year fixed-rate mortgage.
With interest rates being so low, this is a good choice for a 30-year fixed-rate loan. But in this case, I really recommend a 20% down payment or the ability to pay off PMI in a year or two.
Yes, it’s pretty old. But, just like when you pay off debt, saving for a house is a chance to really build your financial strength. It takes time and discipline, but if you can save up for a 20% down payment, you’ve shown that you can handle the financial ups and downs that come with being a homeowner.
FAQs
What are closing costs, and how high are they?
Closing costs are the different things you have to pay for in order to legally own your home. Plan to spend between 3 and 5 percent of the price of your home on closing costs, which can include title fees, an appraisal, taxes, and recording fees.
How much do you have to make a year to afford a $500000 house Canada?
113,000 dollars a year
Keep in mind that you need at least $113,000 per year in income to be able to pay a $500K mortgage rule of thumb.
What mortgage can I afford with 100k salary?
With a 20% down payment and a household income of $100,000, you can probably buy a $560,000 condo without too much trouble. This number is based on the idea that you don’t have much debt and have $112,000 in the bank.
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