Calculating how much house you can afford

There are two ratios that lenders look at to determine how much house you can afford.

1. The first, called the front or top ratio, is simply the ratio of your housing expense
to your gross income. It’s calculated by:
Gross monthly income $7,240 X .30 = $2,172

2. The bottom or back ratio is all of your recurring debts including house payment subtracted from your gross income. This is calculated by:
Gross monthly income $7,240 X.41 = $2,968 monthly recurring debts:
Car loans $545.00
Credit Cards ($150 X $75) equals $225.00
School loans $190.00
Child support $ -0-
Other debts $ -0-
Total monthly debts $960.00
Subtract total debts ($960) from the result of multiplying your gross monthly
income by .41. This equals $2,008.


The lesser of front and back ratio ($2,008) is the amount of the total house payment you can qualify for that includes taxes, insurance, principal, interest, and PMI. The next step is to subtract the taxes, insurance, and PMI to get the principal and interest payment. Since taxes, insurance, and PMI account for roughly 20 percent of the payment, multiplying $2,008 X .80 equals $1,606.
If you have a financial calculator, key in $1,606 for the payment, 6 percent interest on the interest key, and 360 payments (30 years) on the term key. Then hit the PV (present value) or loan amount key, and you’ll get $267,934. Add in the down payment of $29,763, and you’ll get $297,630 as the house price you can write an offer on.
You can also go to www.mortgagexpo.com and click on calculators, then click on What house can I afford? Enter the total payment amount and the calculator will figure out your house price.

How Much Home Can You Afford?

The biggest mistake most homebuyers make is to start looking at homes before they know what they can afford. This often leads to frustration and discouragement when they talk to a lender and find out that their tastes are Mercedes but their income is Yugo. The best and least stressful way is first to determine what house payment you can afford and then go from there.
Although each lender can have a slightly different focus, most like to keep income-to-debt ratios close to the following numbers. Typically, total debt plus the mortgage payment with principal, interest, taxes, and insurance included (PITI) shouldn’t exceed 40 percent of your income before taxes. But in some instances, where the borrower has exceptional assets, credit score, and/or other pluses, this ratio can go as high as 50 percent.
Total house payment (PITI) shouldn’t exceed 30 percent of gross monthly income. Here again, in exceptional cases this ratio can go up to 33 percent.
For first-time homebuyers, however, the 30/40 ratio is probably the one most lenders will be using when they work up the numbers. For example, when Aaron and Ronda decided to buy a home, they sat down and looked at their pay stubs for the last couple of months. Their combined income totaled $7,240 a month before deductions. Adding up their monthly payments—$545 for a car payment, $150 for the Visa card, $75 for the Discover card, and a $190 student loan— totaled $960.

Because of Aaron and Ronda’s good credit score, job history, and their ability to pay a 10 percent down payment, their mortgage lender told them they would be able to afford 41 percent of their income minus their debts.

When you do the math, 0.41 $7,240 equals $2,968.40, and subtracting monthly debts of $960 gives $2,008.40 as the maximum mortgage payment, which includes interest, principal, taxes, insurance, and mortgage insurance premium (MIP).
MIP is an extra insurance policy that insures the lender against borrower default when the down payment is less than 20 percent. The fee, usually .50 to .75 percent of the loan amount is based on your down payment. It can drop off when your equity through pay down or appreciation reaches 20–30 percent.
Monthly taxes, insurance, and MIP are obtained by adding the yearly premiums and then dividing by 12 months. (Property taxes vary considerably from state to state, so call your county assessor for data on your area.)
Assuming that $402, or 20 percent of the payment, goes to taxes, insurance, and MIP ($ 2,008 X 0.2 = $402) and subtracting from $2,008 leaves $1,606. Using a financial calculator and keying in a payment of $1,606, 6.0 percent interest, and 30 years (360 months) gives $267,867 as the maximum loan amount. Since Aaron and Ronda are putting 10 percent down, or $29,763, that is added to the loan amount to get $297,630 as the maximum home price they can write an offer on.

How to Maintain Your Credit?

Credit scams abound where operators promise to ‘‘fix’’ your credit for a few hundred dollars. Unfortunately, there are no quick fixes, magic potions, or silver bullets that will transform a credit rating from bad to good. It’s obviously better to spend the money paying down a credit card than buying into a credit fixing scam that in the end won’t improve your credit.

Credit score reducing traps:

• Avoid preapproved credit card and extended financing offers until after you close.
• Close accounts that you don’t use. Mortgage lenders don’t like to see lots of open accounts.
• Avoid switching insurance companies or refinancing; these often bring on new inquiries. Pay off and close out small, seldom used accounts. Too much credit can be a negative.

Fortunately, there are several things that you can do to improve your score:

• Pay down debt on high-interest credit cards as much as possible.
• Getting balances under one-half the limit is best.
• Limit the number of inquiries on your credit. A flurry of credit checks can raise a red flag and cost you points
• Of course, the best credit builder is making your payments on time. Late payments (30 days or more) are guaranteed to slash points from your FICO score. Y
• our payment history for the past two years has the most weight. Prior problems such as a bankruptcy have less or no impact after two years if you clearly show that you’ve cleaned up your act.
• Work with a reputable mortgage lender. Most lenders will be glad to go over your credit and work up a list of areas you can improve or problems that need to be corrected. They know the credit system and what it takes to get you qualified for the best mortgage rates.

Definitely, don’t follow Barry and Kelli’s example. Their lender told them that with their 720 credit score and stable job history, they wouldn’t have a problem qualifying for the new home they wanted. Excited by the news, they went furniture and appliance shopping, opening a Home Depot and local furniture store account. Barry and Kelli, feeling they were smart shoppers, put their purchases on both stores’ 90-days-free-interest plans.
A few days later when the mortgage lender updated Barry and Kelli’s credit report before submitting to underwriting, she was shocked to find that their FICO score had dropped to 613. The lender had counseled them to avoid any credit applications or transactions until they closed on their mortgage. But in the excitement of their first home, Barry and Kelli got carried away. Unfortunately, this eliminated them from buying their dream home anytime soon.

How to Work with Credit Reporting Agencies?

Three national credit-reporting agencies, Experian, TransUnion, and Equifax Inc., are competing companies that assemble your credit information into numerical scores. A mortgage lender will usually get reports from one or more of these companies when you apply for a home loan. Because each reporting agency gets its information in a slightly different way, it’s not uncommon for your credit score to differ by 20–50 points. That’s not always a problem. Mortgage lenders will typically update discrepancies or reconcile differences in your report(s) to get a current picture of your credit for better (hopefully) or worse (unfortunately).
If there are problems, the lender may ask you to write a short letter explaining your side. Should you have to write one of these letters, keep it short and stick to the facts. Applicants sometimes get carried away and include the family history.
Although FICO credit scoring is the by far the biggest player on the block, a few mortgage investors have developed similar scoring systems to fine tune credit data for their market.
Also, other criteria can be added to the mix to determine your eligibility. For example, FHA (Federal Housing Administration) and VA (Veterans Administration) government insured programs give lenders some leeway to consider your individual situation.

Beware of Subprime Mortgage

If your score is under 620, you may want to consider building your credit before getting locked into a subprime mortgage. With subprimes it’s buyer beware, so you definitely want to read the fine print. These loan programs often have predatory prepayment penalties and inflated terms. It may be worth taking a year or two to repair your credit before buying a home.

Manuel and Geri wanted a home so badly that they went along with a lender who told them they could get a loan, but only at 2 percent over par. They were also told they could refinance in a year and lower their interest rate. Even worse, closing fees cost them nearly 8 percent of the loan, almost double the norm. These fees were added into the loan making the monthly payment even higher.
After a year of making all their payments promptly and paying down much of their debt, Manuel and Geri went in to refinance for a lower rate. It was a shock when they were told that it would cost them nearly $4,000 in prepayment penalties to refinance. Their loan documents had a clause that if the loan was paid off within three years it would cost 4 percent of the loan balance in penalties.
This left the homeowners with few options—continue paying a high interest rate for two more years or pay the prepayment fee—not a good situation. Manuel and Geri may have been better off taking a year or two to clean up some credit problems rather than getting locked into a subprime loan.
However, it can be a difficult call. Some lenders argue that it’s better to get a home now with a subprime loan than wait until real estate values are climbing. That may be true, but before committing to a higher than par interest rate, it’s still a good idea to have a competent financial adviser run the numbers and read the fine print.

How Credit Scoring Affects Your Credit

Because most lending is Internet based, a credit standard is needed to put everyone on the same page. As a result, credit scoring was developed and has become a universal, though sometimes controversial and misunderstood, standard.
FICO scoring, the industry standard, is named after Fair, Isaac and Co. the California-based firm that developed the software. It creates a computer-generated numerical grade that predicts a lender’s risk in loaning you money. Your FICO score can change from day to day depending on what information is available from various credit sources.
When a mortgage lender orders a credit report, the credit bureaus evaluate and assign a numerical score to five different parts of your credit history. Two of the five factors that relate to your payment history and how much current debt you have make up roughly 65 percent of the score. The length of your credit history, recent credit inquires, and type of credit you use make up the remaining 35 percent.
FICO scores range from 300 to about 850, and the better your track record paying loans back promptly the higher your score. Typically, scores of 650 plus get the best rates and terms. Homebuyers with scores in the 620 to 650 range still won’t have a problem finding a mortgage, but the interest rates may start to creep up. Scores under 620 are subprime territory, and interest rates can ratchet up 2 percent or more. Down payments required also climb, sometimes to as high as 30 percent.
When Ron and Wendy applied for a $175,000 mortgage, they didn’t think a couple of 30-day late payments on their two maxed-out Visa cards would cause a problem. But, when their lender called asking about a two-year-old medical collection account they had forgotten about, the situation started to look grim. Ron and Wendy told the lender they thought the insurance company was supposed to pay the bill. But they never took time to follow up and ignored several statements from the clinic. After about four months, the clinic sent the account to a collection agency, which reported to the credit bureau and Ron and Wendy’s credit score took a big hit. Each discount point equals 1 percent of the loan amount, and lenders often charge points to increase their yield (profit) on a below market interest rate.
With a credit score around 600, the lender felt she could still put a loan together
but Ron and Wendy would have to pay off the collection account first. They would also need at least 10 percent down, pay an interest rate one percent higher than the current market rate, plus two discount points.
In real dollars and cents terms a low credit score will cost Ron and Wendy: Two discount points, or $3,150 $104 a month in higher payments or $3,744 over three years. Hopefully, they can get their credit cleared up and refinance to a lower interest rate by then. The bottom line is that your credit score determines how much your mortgage will cost you in interest and closing costs. In Ron and Wendy’s case, not taking their credit seriously cost them $6,894 in penalties.

How to get prepared to qualify for a home loan?

Mortgage lenders are often depicted as shadowy figures who try and find ways to deny applications and keep homebuyers out of their dream house. But in reality, the opposite is true. Lenders work hard and often go the extra mile to make a loan work.

A mortgage broker takes your credit and income data and assembles it into a profile of you as a long-term borrower. Your file is then shopped to various investors by phone, fax, or e-mail. Since the mortgage industry is highly competitive and investors are not all alike in their rates and terms, a good mortgage broker will sift through the offers and negotiate the best deal possible on your file. The investor who agrees to make you a loan, based on the information provided, e-mails a commitment to the mortgage broker. Sometimes there are conditions included or requests for additional information. Once everything is in order, the investor usually e-mails or faxes the loan documents to the title company or closing agent.

Home-Buying Step One: Talk to a Mortgage Lender

Once you’ve decided it’s time to become a homeowner, the first step is to take a look at your financial situation and ask yourself two questions:
(1) Is your job/career reasonably stable for the foreseeable future?
(2) Can you handle a commitment for making monthly payments long term? If you can answer yes to both questions, then it’s time to move on to the next step and talk to a mortgage lender.

What is seller's market?

By contrast, a market vendor, is the result of more buyers than home for sale. Since real estate is a function of supply and demand, the less homes on the market create an increase of all values in the house
The most desirable house price, however, go up faster and top out higher before the market flattens out. The truism, location is everything, becomes obvious in this situation.
Also, when home prices are going up dramatically, entry and midlevel homes become especially hard to find. Since condos and town houses are less expensive to get into and tend to attract first-time homebuyers, this market can explode.
Homeowners who bought when the market pendulum was in buyer’s territory will see their return on investment skyrocket. If you’ve outgrown your condo or town house, this would be the time to cash out and move up.

What is a buyer's market?

No matter what part of the country you’re living in, the real estate market will be in flux. If it’s a buyer’s market and there are lots of homes for sale, it’s good for buyers but not quite so good for home sellers.
This is the time to buy a home. Buyers who do this and then happen to sell when the market pendulum swings to the other side make lots of money. If you can catch the market at the right time, your detached home, condo, or manufactured home will yield a good profit. High interest rates, recession, a local employer shutting down or cutting back on its workforce are some causes of a buyer’s market. In fact, anything that affects the local housing market negatively or seasonally can cause a short or long-term buyer’s market. In this type of market, prices and terms soften. Sellers are more willing to pay buyer concessions to get their home sold. Typical concessions that buyers often get sellers to make are: paying all or part of the closing costs, accepting low offers, throwing in appliances or fixtures, and giving carpeting or painting allowances.
It’s a great market if you want to buy, but not if you have to sell, as Mark and Rachael found out when Mark’s employer consolidated branches and moved his office to another town. That left Mark and Rachael with two choices, either sell and relocate or find a new job in an economically down area. They decided to accept the relocation and sell their three-year-old home. Because they had recently refinanced their mortgage and paid off a few credit cards, Mark and Rachael had little equity left. They had no room to pay concessions or lower their asking price. They were in a financial corner with few options that wouldn’t cost them thousands of dollars in the months ahead. In the end, they had to rent their home to cover as much of the mortgage payment as possible. Eventually, they hoped the market would improve so that they could sell the home for what they owed.

What is the tax advantages of buying a house?

When considering tax, it’s true that the deck is stacked in the homeowner favor. To illustrate, let’s assume both a homeowner and a renter are in the 25 percent tax bracket and earn $60,000 annually. The renter pays $1,000 in rent and the homeowner pays $1,000 a month principal and interest on a $150,307, 30-year loan at 7 percent. The homeowner also pays out $1,500 a year for property taxes.

When tax time rolls around, the difference in taxes paid is significant. The renter pays income taxes on $60,000 income, or $15,000 (25 percent tax bracket times $60,000). The homeowner, however, can deduct $11,973 ($10,473 interest plus $1,500 property taxes) from his $60,000 income before calculating tax liability. Subtracting this deduction from income leaves $48,027.
Multiply this by the 20 percent tax bracket and taxes paid come to $12,007. The savings is $2,993 for the year, or $249 per month. You can also look at it as an $8.30 per day penalty for renting when you divide the monthly savings by 30 days. So no matter how you slice it, Uncle Sam is willing to pay you to become a homeowner! Even though this example is typical case, it’s a good idea to consult a CPA or other tax professional to determine the exact deductions for your situation.

What is Leverage, Appreciation, and Equity?

When a low down payment controls an asset worth many times the money you put down, the financial people call it leverage. For example, if you put $6,000 down on a $200,000 house, your $6,000 controls a $200,000 asset. If the home’s value goes up to $225,000 over the next three years, your $6,000 becomes worth $25,000—a 317 percent return on your investment, thanks to leverage.
When a home’s value increases, it’s called appreciation. In the example above, the appreciation would be $25,000. On the flip side, if the home had gone down in value, there would be depreciation. Another term used a lot in the real estate industry is equity. This is the difference between a home’s current value and the loan balance. It can go up or down, depending on the local real estate market. If a mortgage balance is $200,000 and the current market value is $250,000, the difference of $50,000 is equity.
If you were to talk to a mortgage lender about a second or home equity loan, the lender might tell you she is willing to go up to 90 percent of your equity. Your loan check would then be for $45,000 (90 percent of $50,000) in the above example. In some areas of the country, homes have appreciated dramatically the last few years. If you were to sell and move from a high appreciation area like San Francisco to a lower appreciation area like North Dakota, your equity and the same monthly payment could allow you to buy a significantly larger home.

Although the national economy strongly influences local real estate, the equity you accrue is still dependent on local supply and demand. When you cash out your equity and move to another area, you’ll most likely get either a housing upgrade or suffer sticker shock. This economic reality also applies to renting. Moving from an apartment in Fargo, North Dakota, to New York City would also give you sticker shock, but as a renter you wouldn’t have any equity from your last house to cushion you.

Financial Benefits of Buying a Home

It is plain to see that home ownership is a good financial action. A few its advantages are:

• It is a way that many Americans build and add value net financial stability.
• It can be like a forced savings plan, a way to save for retirement or pay for the children's college. From the decade of 1950, the land and house prices have risen steadily.
• You can pay a small down payment in a large return.
• Standard mortgage payment is stable, rents, on the other hand, are unpredictable and usually always increase.
• If you choose improvements wisely, you can enhance home value and equity, sometimes dramatically.