How do I know if I can afford to take a home loan? If I can, how much?
It’s important to buy a home you can afford to enable you to become a homeowner.
Dubai: It’s important to buy a home you can afford to enable you to become a homeowner. No one wants to end up with a home loan you can’t pay.
So it’s crucial to be realistic about your monthly income and expected expenses, and to leave enough breathing space in your budget for emergencies or unexpected costs that can come up.
People are often advised to spend no more than 28 per cent of monthly income on housing expenses and no more than 36 per cent on total debt — that includes housing as well as things like student loans, car expenses and credit card payments.
The 28/36 per cent rule is the most recommended among experts and tried-and-true home affordability rule that establishes a baseline for what you can afford to pay every month.
Here’s an illustration
To calculate how much 28 per cent of your income is, simply multiply your monthly income by 28. If your monthly income is Dh6,000, for example, your equation should look like this: 6,000 x 28 = 168,000. Now, divide that total by 100. 168,000 ÷ 100 = 1,680.
How do I determine how much house I can afford?
To calculate how much house you can afford, you take into account your household income, monthly debts (for example, car loan and student loan payments) and the amount of available savings for a down payment.
As a home buyer, you’ll want to have a certain level of comfort in understanding your monthly mortgage payments. While your household income and regular monthly debts may be relatively stable, unexpected expenses and unplanned spending can impact your savings.
A good affordability rule of thumb is to have three months of payments, including your housing payment and other monthly debts, in reserve. This will allow you to cover your mortgage payment in case of some unexpected event.
What factors affect my home loan terms?
When mortgage interest rates are near all-time lows, borrowing is made easier for many buyers. However, low rates coupled with limited available listings, have pushed prices up to record highs. But, if your budget works out, it can still be a great time to buy.
Here are some of the factors that can affect your loan terms, which in turn will affect how much you can borrow.
Lenders tend to give the lowest rates to borrowers with the highest credit scores, lowest debt and substantial down payments.
• Credit score
It’s a good idea to get your credit in order before you apply for a mortgage. First, check your credit report. Carefully review your report and note any incorrect information and negative factors.
If you find mistakes on your report, be sure to alert the credit reporting agency right away. Be aware, you might have to prove that the claims are wrong by providing payment history or other evidence. If it’s a case of identity fraud, then you will have to file a report.
• Debt-to-income ratio
Your debt-to-income ratio, or DTI, compares your monthly income to your monthly debt. People with high debt relative to their income will have a higher DTI, and vice versa.
This is an important number because it shows borrowers your bandwidth to assume more debt.
The higher your DTI, the harder it will be to get a mortgage — much less a good interest rate. Many lenders won’t consider a borrower with a DTI above 43 per cent.
How does your debt-to-income ratio impact affordability?
An important metric that your bank uses to calculate the amount of money you can borrow is the DTI ratio — comparing your total monthly debts (for example, your mortgage payments including insurance and any other payments) to your monthly income. So your debt-to-income ratio is essentially all your monthly debt payments divided by your gross monthly income. This number is one way lenders measure your ability to manage the monthly payments to repay the money you plan to borrow.
What DTI ratio is considered ideal?
Depending on your credit score, you may be qualified at a higher DTI ratio, but generally, housing expenses shouldn’t exceed 28 per cent of your monthly income.
For example, if your monthly mortgage payment, with insurance, is Dh1,260 a month and you have a monthly income of Dh4,500, your DTI is 28 per cent. (1260 / 4500 = 0.28)
You can also reverse the process to find what your housing budget should be by multiplying your income by 0.28. In the above example, that would allow a mortgage payment of Dh1,260 to achieve a 28 per cent DTI. (4500 X 0.28 = 1,260)
Your housing budget will be determined partly by the terms of your mortgage, so in addition to doing an accurate calculation of your existing expenses, it’s important to get an accurate picture of your loan terms and shop around to different lenders to find the best offer.
For borrowers, it’s a good idea to pay off as much existing debt as possible to qualify for a mortgage as well as to make room for a mortgage payment. By paying off debt, you’ll be in a better position to manage your monthly costs and open up resources in case you run into emergency expenses.
Monthly expenses are not counted in your DTI, only debt obligations. So you don’t have to include things like utilities, memberships or health insurance.
Here's how to figure out your DTI: An illustration
Add up your total monthly debt and divide it by your monthly income, which is how much you brought home before any deduction.
Add up your monthly debt: Dh1,200 (rent) + Dh200 (car loan) + Dh150 (student loan) + Dh85 (credit card payments), which equals to Dh1,635.
Now, divide your debt (Dh1,635) by your monthly income (Dh4,000). 1,635 ÷ 4,000 = .40875. By rounding up, your DTI is 41 per cent.
If you get rid of the Dh85 monthly credit card payment, for example, your DTI drops to 39 per cent.
Do lenders use the same 28/36 per cent affordability rule?
Like mentioned earlier, the 28/36 per cent rule is commonly used to calculate affordability, but studies show that the rule lenders use to assess how much house you can afford is 36/43. This ratio says that your monthly mortgage costs (which includes insurance) should be no more than 36 per cent of your monthly income, and your total monthly debt (including your anticipated monthly mortgage payment and other debts such as car or student loan payments) should be no more than 43 per cent of your income. For example, if you make Dh3,000 a month (Dh36,000 a year), you can afford a mortgage with a monthly payment no higher than Dh1,080 (Dh3,000 x 0.36). Your total household expense should not exceed Dh1,290 a month (Dh3,000 x 0.43).
• Down payment
Bigger down payments can mean better mortgage rates because lenders taking on less risk by giving you less money and making sure you have more equity in the home.
The loan-to-value ratio, or LTV, takes into account your down payment. The bigger the down payment, the lower the LTV and the less risk the lender will assume.
Loan to Value Ratio (LVR) is calculated by dividing the loan amount by the lender-assessed value of the property. Generally speaking, most lenders consider a LVR of 80 per cent or more as being risky.
What are the LTV norms in the UAE?
For a property purchase price under Dh5 million the maximum loan-to-value (LTV) for an expat is 80 per cent and for a UAE national is 85 per cent. For properties over Dh5 million, this decreases to 70 per cent LTV for expats and to 75 per cent for UAE nationals.
Bottom line? Determine what mortgage payment you can afford based on your income and debt-to-income ratio and learn ways to budget for a home of your own.
Depending on where you live and how much you earn, your annual income could be more than enough to cover a home loan or it could fall short.
Knowing what you can afford can help you take financially sound next steps. The last thing you want to do is jump into a 30-year mortgage that’s too expensive for your budget, even if you can find a lender.
