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 29th, 2019

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 is willing to lend them
• Two main considerations are 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
• The lender assumes on how much house they can afford
• It is not the mortgage underwriters scope of work on the 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 than 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.  The mortgage loan originator will tell borrowers on the maximum mortgage loan amount borrowers can qualify for prior to issuing a pre-approval letter.

• The formula mortgage lenders use is called 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 to 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 are 50%
• However, the minimum credit scores required to qualify for a conventional loan is 620
• You can qualify for an FHA loan with credit scores as low as 500
• However, for home buyers seeking an 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 are reflected on the credit report and dividing this sum by gross monthly income.

• For example, let’s 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?

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
• childcare
• 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.