You have decided it is time to buy a home of your own. You are confident that your personal situation is such that you are able to keep the home for at least 5 years so the next question is affordability. That is a complicated question particularly in today’s tighter lending environment. Let me give you a few guidelines that will help you get a good ballpark number. This is to help you determine if you are generally in the correct price range. However, to fine tune things you will need to speak with a loan officer.
Critical to determining your price point is your down payment. It is loan amount plus down payment that determines your price range.
If you qualify for a $300,000 loan and have $400,000 for a down payment, well, you can buy a $700,000 home.If you have $30,000 for a down payment, then your price range is $330,000.
So we are going to focus on calculating the mortgage you can afford. Add in the down payment for your price point.
When looking at the total mortgage cost, included is principal and interest on the loan (PI), 1/12 of your annual taxes (T), 1/12 of your annual insurance premium (I) and any HOA or condo fees. Some loans may include monthly mortgage insurance and if so, that needs to be added in. That number is tough to calculate as it depends on the loan program, your credit score and the down payment amount. For this exercise, we will not add that in but the amounts can be between $82 and $115 per $100,000 borrowed.
(Quick explanation of mortgage insurance. Mortgage insurance protects lender in the event of a default. If there is shortfall for the lender when they sell a foreclosed property, the mortgage insurance helps make them whole. It protects the lender but the buyer pays the premium. The premium is calculated as a percentage of the loan amount. VA loans do not have mortgage insurance. FHA loans always do and the percentage is the same regardless of down payment. Conventional loans with less than 20% down have mortgage insurance. The rate is highest with 5% down, lower with 10% down and still lower with 15% down. )
Okay, so you have probably been looking a homes in a certain price range and want to know if a lender will give you a loan for that home. Let determine the monthly payments on a few different homes and then see if that number fits into your budget. For this example, we will consider a townhome at $400,000, one at $500,000 and a single family at $600,000 with no HOA. We will also assume 10% down so the loans would be $360,000, $450,000 and $540,000 respectively. The interest rate used is 4.5%. (rates will probably be different when you read this. You can find current market rates at any bank website.)
Here is how to calculate and estimate these numbers:
For the principal and interest, use this calculator;
To estimate taxes use this formula – (price/100)/12.
To estimate the insurance use this formula – (price/1000)*2 for the annual insurance. Then divide the annual insurance/12.
Estimate HOAs at $75 to $100 per month. If a condo, estimate the fees for a garden style at $250 to $350. A high rise can be between $400 and $700 so it is hard to do. Perhaps the listing you are viewing has an exact fee.
So once you get a total monthly payment, how do you determine if you are qualified? There are two major factors a lender considers. The first is your credit score. That will help determine how much flexibility you may have with the 2nd part which is your debt to income ratio.
In general, your total debt to income ratio should not exceed 40%. With certain loans, certain lenders and/or certain situations (great credit, lots of reserves) that ratio can be stretched. Sometimes to 45%, Sometimes a little more.
So for our example above let’s assume the buyer has a family income of $120,000, a monthly car payment of $500, a monthly student loan payment of $250 and minimum credit cards payments of $100 per month (key is minimum required, not what you pay) That totals $850 in misc debt.
With $120,000 annual income, the monthly gross income (MGI) is $10,000 (annual income/12). 40% of the MGI is $4000. Subtract the $850 in monthly debt and a lender would feel comfortable with a monthly mortgage of $3150. Thus in the example above, the townhomes work but the single family would be stretching things a bit. With a $3336 mortgage payment and $850 in debts, the total debt obligation would be $4186 per month or almost 42% of the MGI. With decent credit, most lenders can make that work but it is situational.
One other note on income. If you are salaried, it is simple to calculate. If you get a salary plus bonus, to include bonus income, a lender will need 2 years of bonuses and will average that amount. If you are self employed, you need to be able to show 2 full years of self-employment income to qualify for a loan.
So, the first step is get this ballpark feel for your price range and decide if homes in that price range will work for you. If they do, then the next step is to go to a lender and get a pre-approval completed. For no charge, they will run your credit and give you a more exact price range in which to look/
I know it seems somewhat complicated to make these calculations. I hope this blog has helped. Also know that I am always available to walk you through this if you have any questions. Most of the time, I can easily and quickly calculate your price range. If I sense your situation is complicated, I have several loan officers I can refer to you.
Call any time.