How do lenders figure out how much house I can afford?
January 19, 2007 · Print This Article
Jennifer C asked:
I have seen the calculators on the internet that figure out based on your income and your monthly debt, but are there any other factors that are taken into consideration?
I have seen the calculators on the internet that figure out based on your income and your monthly debt, but are there any other factors that are taken into consideration?
(I have a GOOD credit Score)
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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.
Generally speaking . . . they take your Gross Income ~ income before taxes . . . find 30 % of that number and that is (again generally) deemed the amount that you can afford annual to pay back a mortgage or loan payment.
Where people get into stress in this is that other loans and (say) credit card debt is also taken into consideration and therefore the amount they’d deem appropriate to lend (in the form of mortgage) would decrease because of that.
If you are debt free (no consumer debt on credit cards or other loans outstanding) . . . if you work with 30% of your Annual Gross Income ~ they just work it backwards into the interest rates being current charges to reverse engineer the actual principal amount they are will to lend.
There is a formula lenders use, depending on your type of loan. For instance, on an FHA loan there is 29/41 ratio, meaning the total mortgage payment, including principal and interest, escrow deposit for taxes, hazard insurance, etc cannot exceed 29% of your monthly income. And for the 41% figure, ALL of your monthly bills cannot exceed 41& of your monthly income. Also other factors such as your credit report, and job history are considered. But just ask they lender or portential lender you are working with the criteria and they should be able to tell you. If not, I would be a little wary of working with them.
The formula for a front end and back end ratio are slightly different for different programs and are largely considered as guidelines, not hard and fast rules. Front end ratio is total housing expenses, back end adds in other credit obligations as a percentage of total qualifying gross income. Automatic underwriting programs can stretch or decrease the figures depending on many other factors (manual underwriting can do the same).
Some of the main factors under consideration and taken all in accordance with your overall financial and credit picture are things such as amount of savings, residual income, credit history, and change in new housing expense over current expense amongst many other more minor factors.
An underwriter does his/her best to determine your likeliness to be able to afford and keep your mortgage in good payment history.
28/34 & 29/41 are most common ratios used for front/back for conforming type and government loans. Sub-prime usually allows up to 50% total ratio. Keep in mind that a person making $200,000 per year can more easily afford 41% than a person making $12,000 a year can, because of other necessary expenses in life and this is taken under consideration as well (residual income).
Lenders will use some kind of ratios of your gross monthly income. I’ve seen 28/34 and 29/41 shown here. This is exactly what they will do. Those ratios determine how much of your monthly income you can pay towards housing (first number) and total installment debt (second number).
Then, using the expected interest rate and term of the loan, they calculate what they will lend you. This is where it gets kind of interesting… If you need PMI that will be part of your payment and reduce what you can borrow. Not putting enough down can also cause your interest rate to be a little higher, limiting what you can borrow. Your credit rating plays strongly here as your offered interest rate will depend heavily upon your credit. This had a direct impact to the amount you can borrow.
My final point of warning is: In general a lender will give you enough rope to hang yourself with. In the recent past you could easily get approved for much more loan than you could possibly handle. After speaking with the bank and finding out what your payment might be, spend a couple of months banking the difference between your rent and this payment and find out if it is comfortable for you. You have to live with this payment for a long time!!
good luck!
Great post! I completely understand your question. Money is hard for a lot of people right now since the enconomy is going down. My friend told me about this website of an organization that gives people up to $1500 towards their rent or mortgage. It’s available in most areas, so I think you should check it out.
Hope this helps!