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Health & Fitness

How much home can YOU afford to PURCHASE?

Among the most common questions from a home buyer is "How much home can I afford?" The answer, not surprisingly, is "it depends".

There are no concrete rules for how much home you can afford, or how big your mortgage should be. In part, this is because mortgage lenders will calculate your maximum home purchase price differently from how you might calculate it yourself.

There are TWO approaches to home affordability -- let's examine both.

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Method 1: Let the lender use your Debt To Income ratio to determine your Maximum Purchase Price

When you ask your lender to calculate your maximum home purchase price, they will give very little consideration to your existing home hunt or any properties on which you've considered making an offer.

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Rather than using a specific home for its calculations (or a specific sales price), the bank will consider your annual income and your annual debts, then calculate the maximum-sized mortgage payment which could be added without raising your debt-to-income (DTI) ratio above allowable limits.

Once your lender has found your maximum approvable mortgage payment, it will use today's mortgage rates to "back in" to the maximum allowable loan size.

This method is based on maximizing your debt-to-income ratio, which may not be advisable. However, the DTI-based formula is not meant to show what you should pay for a home -- it's only meant to show you what you could pay for a home.

Lenders will check your debt-to-income ratio in two parts -- the front-end ratio and the back-end ratio.

Debt-to-Income : Front-End Ratio

The first component of the debt-to-income ratio is the "front-end ratio". Front-end ratio compares the expected monthly housing payment to a buyer's monthly income, where "housing payment" includes all of the following obligations :

    Monthly principal + interest payments

    Monthly real estate taxes due

    Monthly homeowners insurance due

    Monthly dues due to an association

Lenders prefer to see front-end DTI of 31% or less. In other words, lenders prefer that 31% or less of your total monthly income allocated to your housing payments.

You can still be approved with a front-end ratio greater than 31%, but it's a little less usual.

Debt-to-Income : Back-End Ratio

The second component of debt-to-income ratio is the "back-end ratio" (overall ratio). Back-end ratio compares the monthly housing payments against a buyer's monthly income, and all other monthly payments, too.

Back-end ratio accounts for all of the following monthly obligations a home buyer may have :

    Monthly housing payment(s)

    Monthly minimum credit card payments

    Monthly child support or alimony

    Monthly car payments for a car loan or lease

    Monthly payments to an installment loan such as a timeshare

In general, lenders want to see a back-end ratio of 41% or less, however, having a DTI over 36% will not disqualify your loan application automatically. Some lenders allow up to 50% back end debt-to-income.

Method 2 : Make Your Own Monthly Household Budget

As a home buyer, you can rely on your lender to tell you how much home you can afford, or you can figure your maximum home purchase price on your own.

In many cases, your lender will approve you for a more expensive home than you want to purchase. This is because banks will approve you to your maximum home price using their maximum allowed debt-to-income ratio.

Caution - When you spend 45%+ of your income monthly, it doesn't leave much cash for saving, investing or living, let alone paying taxes.

Therefore, consider the other approach to the "How much home can I afford" question. Determine the maximum monthly payment you'd like to make each month, and then, using today's mortgage rates, work that figure backward to find your maximum mortgage loan size.

For example, if you budget for a monthly housing payment of $2,500 with 1.60% of the purchase price annually going to taxes and insurance, assuming the current 30-year mortgage rate is 4%, the math "worked backwards" reveals a maximum home purchase price of $419,000.

This method can be far more effective to keeping within a budget as compared to letting your lender set your price.

To answer "How much home can I afford?", ultimately, requires a buyer to know today's mortgage rates. Mortgage rates affect monthly payments which, in turn, affect your budget.

Mortgage interest rates change daily (sometimes more than once a day) so ask your lender to give you a range to be safe.  Today’s rates are ranging in the 4% and are subject to credit/income/property approval.

If you’d like more information on this topic I’d enjoy hearing from you.

 

Brenda McCracken – This blog is solely the author’s opinion and not the opinion of Stearns Lending LLC

707-322-9481

NMLS 1042557

Stearns Lending LLC

NMLS 1854





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