HOW MUCH CAN YOU AFFORD IN A HOUSE PAYMENT
(BEFORE YOUR WALLET CRIES FOR MERCY)
Published Date 6/23/2017 Source: TBWS
This is the age-old question. There really are two answers: how much do you want to buy, and how much will the lender qualify you to buy.
The first answer is entirely up to you. The second answer is the lender’s decision. Here’s how they determine how much money they’ll lend you.
You should be familiar with an important term: debt-to-income ratio (DTI). Lenders use this number to decide whether they’ll approve your loan.
The lender calculates your DTI starting with your gross monthly income (before taxes). If you receive overtime or bonuses, they’ll verify that you’ve received either for at least two years and average them over that time. If you’ve just started getting overtime or a bonus, you won’t be able to use them as a source of income to qualify.
Next, the lender will add up your total house payment, including principal and interest payment, taxes, insurance, and mortgage insurance and homeowner’s association dues, if any. This is the “housing expense.”
All your monthly debt payments—car loans, credit card minimums, student loans, alimony/child support, etc., are added to your housing expense. If any of your installment loans (car loans or student loans) have less than ten months remaining, you’ll be able to ignore them in most cases. The sum of your housing expense and other debt payments is called “total debt.” You will not have to consider other monthly payments, such as phone and utility bills, health insurance, auto insurance or rent.
Dividing your total debt by your gross monthly income results in a percentage called debt-to-income ratio, or DTI. Lenders can approve an applicant with a DTI as high as 50%.
Here’s an example: You earn $7,500 per month. You’re looking at a house where your mortgage payment will be $1,960, property taxes $520 and insurance $65. Your total house payment will be $2,546. In addition, you have a $350 car payment, $100 student loan payment and $50 in credit card minimums, totaling $500 per month. Your total debt is $3,046. Your DTI is 40.6% (3,046 / 7500 = .406 = 40.6%). If your down payment is less than 20%, the lender will require mortgage insurance (MI). This is because they consider a smaller down payment to present more risk to them. The MI policy, which you’ll pay monthly, limits that risk so that they’ll be willing to make the loan. The cost of MI will vary according to your credit score and the loan-to-value ratio. Mortgage insurance for a 90% loan will cost between .31% for a borrower with a 760 credit score and 1.1% for a borrower with a 620 score. Lenders will allow you to drop MI once you can document that the loan is 80% of the home’s market value or less.
If you have less cash to use as a down payment, your maximum purchasing power will be lower. If your income is $7,500 per month and your other debt payments are $500, you’ll qualify for about $635,000 with a 20% down payment. With a 10% down payment, this number drops to $535,000. The reason is that you’ll pay $206 per month in mortgage insurance, and that affects your DTI.
What if you’re one of those new home buyers, just starting out in the workforce? You get plenty of overtime but have only been getting it for the past year. The lender won’t consider that income when they analyze your loan application. In a case like this, you may be able to bring a “non-occupant co-borrower” on board to apply with you. This person is typically a parent or other close relative. They would apply for the loan along with you, blending their income and monthly payments along with yours. This could be all you’d need to get your DTI into approval territory.
You may discover that you can qualify for more home—with a larger monthly payment—than you really want to spend. You should always be guided by your ideas of a comfortable mortgage payment. Although there are hundreds, if not thousands, of free mortgage calculators available online, your best (and most accurate) information will always come from a local loan officer.