April 29, 2009

How Much Home Can I Afford?

One of the first things people should consider upon deciding to buy a home is how much of a home will they qualify for and does that comfortably fit into their budget. Trying to figure that out can be a little tricky since most people only buy three to four homes in their entire lives. First, let me say that what you qualify for and what you can afford are usually two totally different numbers because lenders will often qualify you for more than you can truly afford.

My advice is to always stay within your comfortable limits!

When you apply for a mortgage, lenders will look at two things to determine how much you can afford monthly:

Your total monthly mortgage payment compared to your monthly gross (pre-tax) income and
Your total monthly debt (including the mortgage) compared to your monthly gross income.

Lenders refer to these two calculations as Debt-to-Income ratios (DTI). They want to know how your debt compares to your income. The first one listed above is called your Front End Ratio and the second one is called your Back End Ratio. The way to calculate these are:

First figure out your monthly gross income. If you are paid every 2 weeks, multiply that amount by your 26 pay periods per year and then divide by 12 to get an accurate monthly income.
Determine what you can comfortably afford for a home payment each month
Then divide that payment by your monthly income. This will give you your front end ratio.

Most lenders want your front end ratio to be no more than 33%, but there are programs out there that allow that amount to be higher.

To calculate your back end ratio:

Add your total monthly debts together (car, credit cards, student loans)
Add that to your home mortgage payment to get your total monthly debt payments.
Then divide that payment by your monthly income. This will give you your back end ratio.

Back end ratios can range from 41% to 55%. You’ll want to just talk to a mortgage loan officer to get more detail as to what you can get, but this will give you a good idea of what you qualify for. One additional piece of advice I could offer, pay down and pay off debts because a $5,000 debt could equal $20,000 more of a house! That’s the kind of math that most people like.

Posted By: Brad & Liz Sears