How Much Can I Borrow For My Home Purchase?

Refinance Mortgage

Gustan Cho Associates

Home buyers, especially first time home buyers, often ask the question ” How much can I borrow”? before they start looking for a home.  They need to know how much the maximum home loan amount the mortgage lender are willing to lend them and also need to consider whether the monthly payments are affordable for them.  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.  What a mortgage lender assumes on how much house they can afford is not the actual amount of how much house they can afford depending on their lifestyle.  Often times, home buyers will capitalize on the maximum amount the mortgage lender is willing to lend them and 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 you can borrow on a home loan.  Your mortgage loan originator will tell you on the maximum mortgage loan amount you qualify for prior to issuing you a 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

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 FICO is 46.9%.  The maximum front end debt to income ratios allowed for FHA loans if your credit scores are under 620 FICO 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 FICO.  You can qualify for a FHA loan with credit scores as low as 530 FICO.  However, for home buyers seeking a FHA loan with credit scores between 530 FICO and 579 FICO, 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 FICO or higher.

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 your credit report and dividing this sum by your gross monthly income.  For example, lets use the top example where the monthly PITI is $1,000.  If your monthly housing principal, interest, taxes, and insurance payment is $1,000 but you have a car payment of $250.00, student loans of $250.00, child support of $250.00, and a motorcycle payment of $250.00, your total monthly minimum payments are calculated at $2,000.00 per month.  If you take the total monthly minimum payment of $2,000.00 per month and divide it by your gross monthly income of $4,000.00, that yields 50%.  The 50% number is your 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” and how much your maximum mortgage lending limit will be by your mortgage lender.

As mentioned earlier, the maximum you can borrow on a conventional loan will be based on your maximum debt to income ratio of 45%.  Your monthly housing payment is determined not just by the loan amount but also by your property taxes, insurance, and mortgage insurance.  If your monthly gross income is $4,000.00, the maximum debt to income ratio you can have is 45% which mean that your 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 your property taxes are $100.00 per month and your homeowners insurance is $100.00 and your 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 you can borrow is $325,000 if you have 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 the maximum back end debt to income ratio permitted is 56.9% if your credit scores are 620 FICO or greater and your mortgage lender does not they their own mortgage lender overlays.  If your credit scores are lower than 620 FICO, then the maximum front end debt to income ratio is capped at 31% and the maximum debt to income ratio is capped at 43%.

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 you how much you can borrow does not mean that you can actually afford what the mortgage lender qualifies you for.  Mortgage lenders do not know your lifestyle and do not calculate the monthly utility payments, your child care, your entertainment allowance, your annual vacation expenses, and your tuition if you are going to school.  You also need to take into consideration that being a homeowner comes with much added financial responsibilities than being a renter.  You need to have reserves in the event if your HVAC system breaks down, need a new well, need a new roof, or need any other repairs.

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The information contained on Gustan Cho Associates website is for informational purposes only and is not an advertisement for products offered by The Gustan Cho Team @ Gustan Cho Associates or its affiliates. The views and opinions expressed herein are those of the author and/or guest writers of Gustan Cho Associates Mortgage & Real Estate Information Resource Center website and do not reflect the policy of Gustan Cho Associates Lenders Network, its officers, subsidiaries, parent, or affiliates.

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