First Time Home Buyers: How Much House Can I Afford?
First time home buyers as well as seasoned home buyers need to consider ” How much house can I afford?”. Mortgage lenders will qualify you for the maximum housing budget that you can afford, however, just because the mortgage lender approves you for a residential mortgage loan based on your down payment, income, and credit history does not mean that you can afford your new home purchase and still maintain your lifestyle of living when you were a renter or if you are upgrading to a bigger more expensive home. Just because a mortgage lender qualifies you and is willing to lend you the funds to purchase your home and deems that you can afford it, that does not mean that you can actually afford it. Mortgage lenders will not take into account how much your personal monthly budget is. Liabilities like utility bills, private school bills, helping out your elderly payments, supporting your kids for college tuition, vacations, pet care, hobbies, and other personal expenses are not considered by mortgage lenders and these added expenses are expenses that you, as a homeowner, need to seriously consider and decide whether a particular home that you want to purchase is realistically affordable and that it will not make a big dent in your lifestyle. We will cover the question of how mortgage lenders calculate on how much home you can afford as well as helping you answer the question of “HOW MUCH HOME CAN I AFFORD” in this blog and hopefully this article will be helpful in helping you decide.
How Mortgage Lenders Calculate On How Much Home You Can Afford: Debt To Income Ratio Explained!
How much home you can afford is not based on how expensive the value of your home purchase is. It is how much your monthly housing payment that consists of principal, interest, taxes, and insurance based on the balance of your mortgage loan is as well your other monthly expenses. Homeowner association dues as well as mortgage insurance premiums are also added in calculating both your front end debt to income ratios as well as you back end debt to income ratios. Your front end debt to income and back end debt to income ratios are calculated based on your monthly gross income. Mortgage lenders calculate your front end debt to income ratios by taking the sum of all of your minimum housing monthly payment which consists of your principal, interest, taxes, interest, homeowners association dues, and mortgage insurance premium and dividing it by your gross monthly income. For example, if you make $3,000 gross per month and your minimum housing payment is $1,000, then your front end debt to income ratios is 33%. The maximum front end housing ratios allowed for FHA is 46.9%. There are no front end debt to income ratio requirement for conventional loan programs, however, the maximum debt to income ratios allowed per conventional loan mortgage lending guidelines is 45% in order to be able to get an approve eligible per DU or LP FINDINGS which is the Automated Underwriting System. Just because the maximum front end debt to income ratios are capped at 46.9%, that does not mean all mortgage lenders will allow you to have the 46.9% debt to income ratios. Many mortgage lenders have something called mortgage lender overlays which is their own added mortgage lending guideline on top of the mandatory federal mortgage lending guidelines. For example, if your front end ratio is at 46.9% and you go to MORTGAGE LENDER A, MORTGAGE LENDER A may impose their own front end debt to income ratio cap at no greater than 31%. On cases like these, you may have to choose a mortgage lender who has no mortgage lender overlays on front end debt to income ratios and just goes off the automated findings generated by the Automated Underwriting System, also known as AUS.
Debt To Income Ratio
The second debt to income ratio component that mortgage lenders consider in calculating on how much home a home buyer can afford is the back end debt to income ratios. The back end debt to income ratios takes into consideration the sum of the housing payments as well as the mortgage loan borrower’s all other minimum monthly payments which includes minimum auto payments, minimum credit card payments, minimum student loan monthly payments, minimum monthly child support payments, minimum monthly alimony payments, and all other minimum monthly payments that is reflected on the mortgage loan borrower’s credit report. Lets take a case example: Say the mortgage loan borrower proposed monthly minimum payment of his new home is $1,000.00. The mortgage loan borrower also has a $200.00 monthly minimum car payment, $50.00 minimum Capital One Credit Card minimum payment, $100.00 minimum student loan payment, and $200.00 minimum child support payment. If you add the sum of the mortgage loan borrower’s other payments, the monthly expenses that the mortgage loan borrower is obligated to pay each month is $550.00 per month. If you add the housing payment of $1,000.00 which includes the principal, interest, taxes, insurance, mortgage insurance, and homeowners association fees to the mortgage loan borrower’s other monthly minimum payments of $550.00, it yield a total sume of $1,550.00 per month. Say the mortgage loan borrower has a $3,000 monthly gross income. The back end debt to income ratio is calculated by dividing the total of the mortgage loan borrower’s expenses of $1,550.00 by the mortgage loan borrower’s gross monthly income of $3,000.00 which yields a back end debt to income ratio of 52%.
Automated Approval Via Automated Underwriting System
To get an approve eligible per FANNIE MAE and/or FREDDIE MAC AUTOMATED UNDERWRITING SYSTEM, AUS, for FHA, the maximum back end debt to income ratio that is allowed is 56.9% for those mortgage loan applicants with credit scores of 620 FICO or higher. For mortgage loan applicants with FICO credit scores lower than 620 FICO, the back end debt to income ratio is lowered to 43%. Again, as with front end debt to income ratio caps, many mortgage lenders do have their own internal mortgage lender overlays on back end debt to income ratio requirements. Many banks and credit unions do cap back end debt to income ratios to 40% DTI. If you run into a case where the mortgage lender denies your mortgage loan application due to high debt to income ratios, you need to seek a mortgage lender that has no mortgage lender overlays and will just go off the automated findings per DU or LP FINDINGS, which is Fannie Mae’s or Freddie Mac’s Automated Underwriting System automated approval.
So on this particular scenario, the maximum a mortgage lender will approve for a mortgage loan applicant who is making a gross income of $3,000.00 per month is the following:
FRONT END DEBT TO INCOME RATIO REQUIREMENT IS CAPPED AT 46.9%: 46.9% of the borrower’s $3,000.00 gross monthly income is $1,407.00.
BACK END DEBT TO INCOME RATIO REQUIREMENT IS CAPPED AT 56.9%: 56.9% of the borrower’s $3,000.00 gross monthly income is $1,707.00.
The mortgage lender will deem the above case study scenario of the above borrower as a mortgage loan borrower that can afford the above type of payments. The mortgage lender did not take into consideration the mortgage loan borrower’s private monthly expenses such as utility payments, auto insurance payments, private education payments, summer camps, maintenance expenses, and any other expenses that is not reported on the borrower’s credit report. The question of how much house can I afford needs to be asked and answered by the home buyer.
Homeowner Versus Renter
There are many more advantages of being a homeowner than being a renter, however, with the many advantages comes disadvantages as well. Renters do not have to worry about maintenance expenses, however, being a homeowner comes the responsibilities of maintenance such as mowing your lawn, trimming trees and shrubs, and needing to repair or replace appliances when they break down and fixing plumbing, electric, and HVAC when they break down. Some of these repairs can be quite costly and it is suggested that all homeowners have reserves. If you are barely getting by and all of a sudden your furnace breaks down in the middle of a sub zero temperature winter and need a new furnace, where is the money going to come from? Homeowners should set aside a certain budget towards reserves in the event of unexpected expenses.