How Much Can I Borrow Versus How Much Can I Afford

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How Much Can I Borrow Versus How Much Can I Afford

This BLOG On How Much Can I Borrow Versus How Much Can I Afford Was UPDATED On April 30th, 2018

Home buyers, especially first time home buyers, often ask the question ” How much can I borrow”? before they start looking for a home. How much can I borrower is very different than how much can I afford.

  • They need to know how much the maximum home loan amount the mortgage lender are willing to lend them
  • Two main considerations is how much can I borrower versus home much can I afford
  • Equally as important is they also need to consider whether the monthly payments are affordable for the new homeowner
  • Just because a mortgage lender is willing to lend them X amount of dollars does not mean that they will be comfortable with X amount of housing payments
  • Lender assumes on how much house they can afford
  • It is not the mortgage underwriters scope of work on actual amount of how much house they can afford depending on their lifestyle
  • Mortgage Underwriters main concern for borrowers is how much can I afford
  • Often times, home buyers will capitalize on the maximum amount the lender is willing to lend them
  • They often regret that they are barely getting by after they close on their new home
  • Mortgage lenders do not take expenses such as entertainment expenses, child care, utilities, and other monthly expenses not listed on the mortgage application so what a mortgage lender states on how much home you can afford is different that how much home you can afford with your existing lifestyle

Mortgage Lenders Formula On How Much I Can Borrow For My Home Purchase

Mortgage loan underwriters use a specific formula in calculating on how much I can borrow on a home loan.  Mortgage loan originator will tell borrowrs on the maximum mortgage loan amount borrowers can qualify for prior to issuing pre-approval letter.

  • The formula mortgage lenders use is call the debt to income ratio
  • There are two debt to income ratios mortgage lenders go by
  • The first is the front end debt to income ratio and the second is the back end debt to income ratio

Front End Debt To Income Ratio On How Much I Can Borrower

The front end debt to income ratio is also known as the housing ratio.

  • The front end debt to income ratio is calculated by adding the principal, interest, taxes, and insurance ( Often referred as PITI ) and dividing it by your monthly gross income
  • This percentage is called the front end debt to income ratio
  • For example, if the sum of your principal, interest, taxes, and insurance is $1,000 and your monthly gross income is $4,000, then if you take your housing payment of $1,000 and divide it by your monthly gross income of $4,000, you front end debt to income ratio is at 25%
  • Maximum front end debt to income ratios allowed for FHA loans if your credit scores are over 620 is 46.9%
  • The maximum front end debt to income ratios allowed for FHA loans if your credit scores are under 620 is 31%
  • For conventional loans, they just go off the back to end debt to income ratios which is 45%
  • However, the minimum credit scores required to qualify for a conventional loan is 620
  • You can qualify for a FHA loan with credit scores as low as 500
  • However, for home buyers seeking a FHA loan with credit scores between 500 and 579, a minimum 10% down payment is required
  • To qualify for a 3.5% down payment FHA loan, you need a minimum credit score of 580 or higher.

How Much I Can Borrower And Qualify With Back End Debt To Income Ratio 

The back end debt to income ratio is the sum of your housing payment plus all other minimum monthly payments that is reflected on credit report and dividing this sum by gross monthly income.

  • For example, lets use the top example where the monthly PITI is $1,000
  • If monthly housing principal, interest, taxes, and insurance payment is $1,000 with the following:
    • have a car payment of $250.00
    • student loans of $250.00
    • child support of $250.00
    • motorcycle payment of $250.00
  • Total monthly minimum payments are calculated at $2,000.00 per month
  • Taking total monthly minimum payment of $2,000.00 per month and divide it by gross monthly income of $4,000.00 yields 50%
  • The 50% number is back end debt to income ratio

How My Lender Will Figure On How Much Can I Borrow?

Now that we clarified what the front end debt to income ratio and the back end debt to income ratio is, you can now figure out your question of ” How much I borrow”. How much maximum mortgage payment can be will be calculated by lender.

  • As mentioned earlier, the maximum you can borrow on a conventional loan will be based on maximum debt to income ratio of 45%
  • Monthly housing payment is determined not just by the loan amount
  • But also by property taxes, insurance, and mortgage insurance
  • If monthly gross income is $4,000.00 here is a case scenario
    • the maximum debt to income ratio borrowers can have is 45% on conventional loans
    • which mean that monthly budget with the proposed new housing payment cannot exceed 0.45% X $4,000.00 which yields $1,800.00 per month
    • Lets say the following expenses are on this case scenario:
      • property taxes are $100.00 per mont
      • homeowners insurance is $100.00
      • net mortgage principal and interest payment is $1,600.00
      • A $1,600.00 monthly principal and interest mortgage payment at a 4.25% 30 year fixed rate term is equivalent to a $325,000 loan amount
      • The maximum loan amount borrower will qualify for  is $325,000 with no other minimum monthly payments but just the proposed housing payment
For FHA loans, the maximum front end debt to income ratio permitted is 46.9% and maximum back end debt to income ratio permitted is 56.9% to get an approve/eligible per Automated Underwriting System. This applies if borrowers credit scores are 620 or greater. Many lenders have overlays on debt to income ratios and credit scores. Make sure the mortgage lender does not they their own mortgage lender overlays.  If credit scores are lower than 620, then the maximum debt to income ratio is capped at 43% to get an approve/eligible per Automated Underwriting System Approval .There is no front end debt to income ratio requirements on under 620 credit score borrowers unless lender has front end DTI Overlays.

What The Lender Says On How Much I Can Borrow Does Not Mean I Can Afford The Monthly Payments

Just because a mortgage lender will tell borrowers how much can I borrow does not mean homeowners can actually afford what the mortgage lender qualifies for.  Mortgage lenders do not know borrowers lifestyle. They also do not calculate the monthly budget of the following:

  • utility payments
  • child care
  • entertainment allowance
  • annual vacation expenses
  • tuition if going to school

Homeowners also need to take into consideration that being a homeowner comes with much added financial responsibilities than being a renter.  Homeowners need to have reserves in the event if HVAC system breaks down, need a new well, need a new roof, or need any other repairs.

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