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.
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.
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