No one wants to buy a home, only to discover that they can't
afford it and end up with their home in foreclosure. That's why it's so
important to be realistic about what you think you can afford, now and in
the future.
Qualifying ratios are used by underwriters to determine the
amount of money that you should spend on your mortgage in relation to your
income and expenses. Government and conventional programs have more lenient
requirements for low- and moderate-income families, and usually require
that you receive financial counseling. Underwriters can use one of three
ratios to qualify you for a loan, but each application is handled on an
individual basis.
As a rule, your housing expenses should not exceed 26 to 28
percent of your gross monthly income. The FHA ratio is 29 percent of your
gross monthly income. Monthly housing costs include the mortgage principal,
interest, taxes, and insurance (PITI).
Loan
to Value
The loan-to-value (LTV) ratio is the total mortgage amount
divided by the fair market value of the house. This is the most
important ratio.
Debt
Service Coverage Ratio
The debt service coverage ratio
(DSCR) is only used for large
loans on income producing properties.
How
it Works
Divide your annual
income by 12 months. For example, if your annual income is $50,000
divided by 12, your gross monthly income is $4167.
Multiply your monthly
income by .28 to find out how much you can afford for your mortgage
payment. $4167 multiplied by .28 is $1167. You would probably qualify
for a conventional home loan that requires monthly payments of $1167.
If your long-term debt
is used in the qualifying ratio, debts such car payments, the total of
your PITI and long-term debt should not consume more than 33 to 36
percent of your gross monthly income for a conventional loan.
Multiply your gross
monthly income by .36. $4167 multiplied by .36 is $1500.
Add your PITI to the
amount of your long-term expenses and this amount cannot exceed $2667
to qualify for a conventional loan.
What is the outlook for
your (and your co-borrower, if there is one) employment?
What is the current
mortgage interest rate? Even a small difference in the interest rate
will make a significant difference in your house payment and overall
loan cost. (Can you give me an example?)
What
You Can Do
To avoid wasted time and heartbreak when you start house
hunting, you have some homework to do!
List your assets:
Income (don't forget
dividends, alimony, and child support)
Savings
Investments
IRAs, 401Ks, or KEOGH
plans
Cash value of your life
insurance
Equity in real estate
Gifts, if you are
planning to get cash from relatives
Now, list your liabilities:
Credit cards
Loans, including car,
education, and so forth
Spousal support
Child support
Anticipate inevitable home ownership expenses such as:
Homeowners insurance
Taxes
Maintenance costs
Utilities
Homeowners fees
When you're ready to start figuring out how much you can
afford to spend for a home, here's a calculator that
will give you a rough estimate. Feel free to use the calculator as often as
you wish until you're satisfied with the result.
