The three largest purchases you’ll make in a lifetime are most likely your home, your education and your car. Before you start looking at any of these, you’ll have to ask yourself “How much can I borrow?” In each case, you’ll probably want to buy more than you can afford, so you’ll need these basic guidelines to bring you back down to earth.
These are, by the way, the same guidelines lenders follow, but they’ll also factor in your credit score and previous payment history. That means, while you’re asking yourself “How much can I borrow,” the lenders will be looking at how much you can afford to borrow.
How much can I borrow for a house?
The first place to start is with your down payment. The rule of thumb is that you should have a down payment equal to 10 to 20% of the home’s price. Since the median price of a new home is currently $204,000, you need to save roughly $30,000. Consider consolidating debt with a personal loan a year in advance.
To get the best deal on your mortgage, you need a good excellent credit score, and that mean your debt to income ratio (DTI) should less than 36% of your gross income. If your annual earnings match the median salary of $70,000 for a family of four, that means you should have no more than $25,200 in debt, not counting your housing costs.
Your monthly payment should be no more than 28% of your monthly gross income. Again, if you’re that Average Joe all our numbers are based on, your monthly payment—including principal, interest, taxes and insurance—should be no more than $1,633.
How much can I borrow for my education?
Your monthly payments should be no more than 10% of the projected monthly income of your first job out of college. For instance, the average student loan debt for an undergraduate education is $21,000. Paying 8% interest on those student loans for a 10-year term will cost $250 a month. If your first job out of college pays at least $30,000, you should be able to make the payments without too much trouble, IF you avoid amassing a lot of credit card debt while you’re in school.
How much can I borrow for a car?
When you’re asking yourself what you can afford, be sure to add in expenses like insurance, gas, maintenance and depreciation, which add a lot to the cost of car ownership. For instance, the manufacturer’s suggested retail price for a gas-sipping 2010 Toyota Prius is $22,400; add in those addition expenses and the real cost is $35,307. Before you buy, check out the True Cost to Own™ calculator at Edmunds.com. And remember, you can’t let your monthly car payment push you over that 36% DTI.
The decision making process for all purchases should always begin with “How much can I afford?” instead of “How much can I borrow?” By using these guidelines, you’ll know what to expect from your lender, and avoid getting in over your head if you run into an unscrupulous loan officer.