When calulating how much house you can afford, what is included in monthly debt?
February 4, 2008 · Print This Article
Michelle M asked:
I’m trying to figure out how much house I can afford based on a certain income. It asks how much monthly debt I owe. Would I include car payments and insurance? I have zero credit card debt and zero student loan debt, so would I just put in zero??
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I’m trying to figure out how much house I can afford based on a certain income. It asks how much monthly debt I owe. Would I include car payments and insurance? I have zero credit card debt and zero student loan debt, so would I just put in zero??
Create a video blog…instantly.
Josh Dunaway has been a certfied Realtor in the suburban Chicagoland area for over 20 years. Aside from starting his own real estate company, he also owns a mortgage company as well.
If there isn’t a place for regular monthly bills, put all of your monthly expenses in there. If you think it’s strictly for credit card debt, put a 0.
Well this is for Australia, it may be different in other countries..
For every $5,000 of credit card LIMIT (not what you owe, but what you CAN owe); your borrowing capacity decreases around $17,000.
A couple on one income qualifies for around $50,000 less than a single person on the same income.
Every dependant child decreases your borrowing capacity by around $40,000.
Every $100 in monthly repayments for a personal loan (be it for a car, holiday, whatever) decreases your borrowing capacity by around $12,000.
Posted by: First-Time HomeBuyer Magazine Monday, March 31, 2008
The Affordability Factor
How can you decide whether or not you can afford to buy a home? The biggest part of house affordability is the interest rate because it determines your monthly principal and interest payment. Let’s look at a $100,000 loan amount, a thirty-year fixed rate mortgage, interest rates, and monthly payments. The table below shows the difference the interest rate can make.
Loan Amount: $100,000
Thirty-Year Fixed-Rate Mortgage
Interest Rate Payment
5.50% $567.79
6.00% $599.55
6.50% $632.07
7.00% $665.30
7.50% $699.22
These figures do not include payments for property taxes and homeowners insurance, items that need to be considered as well. The four elements together–principal, interest, taxes, and insurance–make up your monthly house payment.
Let’s say the monthly homeowners insurance premium is $125.00 and the annual taxes, when spread over twelve months, equals $225.00 per month. That would mean, with a 6.50% interest rate, the total payment would be $982.07 ($632.07 + $125.00 + $225.00). There is a fifth element, mortgage insurance, which is required if a borrower puts down less than 20% toward the home purchase. Mortgage insurance protects the lender in the event a borrower defaults on the loan. A lender determines which type of mortgage insurance is required for the type of mortgage loan taken out by the borrower. The mortgage insurance payment is included in the total mortgage payment each month. For the first-time homebuyer especially, it is important to keep all these factors in mind.
After you figure your monthly payments, the down payment and closing costs are the second thing to consider to determine affordability. If you have never bought a home, it can be a very intimidating experience. You go out house hunting, you find the house that fits you, and then you start the process of buying the house. How much have you saved for a down payment? Most people think about that. They don’t, however, think about the closing costs, which also have to be paid at the beginning. These costs include fees to the bank or mortgage company; fees to the title/escrow company (the business that will take care of all the documentation and put the title and ownership in your name); and initial payments for taxes, insurance, and other things. As you can see, there are two parts to making sure your house is affordable for you, both when you buy the house and as you pay for the house.
In addition you would include car payments, insurance and any other regular monthly payments that you make. All of these costs totaled together determine the amount of money you will need each month to meet your obligations. If the total exceeds your monthly income then you cannot afford the house.
When calculating how much home you can afford to buy, lenders use debt to income ratios (DTI) to determine how much you can safely borrow. There are two ratios used, front and back end ratios.
The front end ratio is a measurement of the total monthly house obligations. The acronym PITI is commonly used. It stands for Principle, Interest, Taxes and Insurance. The Principle and Interest represents the montly mortgage payment, Taxes are the property taxes broken down to monthly increments, and Hazard Insurance to insure the structure from fire, natural disasters, etc. PITI would also include monthly mortgage insurance payments and Association dues/fees if applicable. The total of all of these monthly house expenses divided by your monthly gross income will be your front end ratio.
For conforming loans, the front end ratio is typically 28%
For FHA loans, the ratio is 31%.
Example:
Principle and interest payments= $1500
Property Taxes= $250
Insurance= $250
Total housing expenses= $2000
Gross annual income= $85,000
Gross monthly income= $7083 ($85,000 / 12 months)
Front end DTI= $2000 / $7083 = 28%
The back end ratio adds all monthly recurring debt to the total house debt to arrive at the back end ratio.
For conforming loans, the back end ratio is typically 36%
For FHA loans, the ratio is 43%.
Example:
Car payment= $200
Credit card payments= $200
Student loan= $150
PITI= $2000
Total monthly debt obligations= $2550
Back end DTI = $2550 / $7083 = 36%
Calculating FHA loans are a little different. I saw a great site that shows how to calculate FHA DTI ratios.
Hope this helps. Good luck to you.
Elliot Lau, Realtor of 22 years
Yes your debt includes your car payments and insurance. If it is a monthly debt it counts as those are expenses you deal with month to month.