How Much Mortgage Can You Afford?
For anyone thinking about purchasing a home, it’s the most fundamental question: How much mortgage can you afford?
Put another way, with today’s interest rates, tough underwriting rules and the down payment cash that you can put together, what mortgage amount might a lender approve you for, given your income, debts and credit scores?
Many home shoppers opt for a “quick fix” answer by visiting websites that provide an online calculator. That’s fine, except that simply entering your monthly income, expenses and what you believe to be your credit score in a computer program won’t accurately predict what a specific lender will actually agree to lend you. More important, it won’t give you insights into the often flexible, case-by-case factors that lenders can use to get your loan application approved.
Here’s an overview of what really matters to lenders and how you can more accurately predict whether you’ll qualify for a given loan amount or not.
Mortgage Secret #1: Ratios are hugely important.
Every mortgage lender uses debt-to-income (DTI) ratios to arrive at a baseline judgment about your financial capacity to repay a loan. The idea is to measure your gross monthly household income and compare it to two types of debt:
The money you spend each month on core housing-related expenses combined;
And the amount you spend on non-housing debts, such as credit cards, auto loans, student loans, etc.
If you need to devote too high a percentage of your monthly income to pay off debts, then you may not have enough left over for food, clothing, transportation and other essentials. To a mortgage lender, that means (statistically, at least) that a buyer will likely fall behind on mortgage payments.
For example, say your monthly gross income before taxes and other deductions is $6,000. If your monthly payments for housing-related and other debt total $3,000 — an overall DTI ratio of 50 percent — most lenders will tell you that you need to lower that ratio significantly. To calculate your debt to income, lenders typically focus on these two specific ratios:
Your Housing Ratio:
How much will your key housing-related expenses total per month and what percentage of your income will they represent?
Your key housing costs include:
Principal, interest, property taxes and hazard insurance on the loan you’re applying for;
Homeowners association, condominium or cooperative fees that you are required to pay;
Any additional fees required for your mortgage or property, such as flood insurance or mortgage insurance premiums.
Say your housing costs are projected to come to about $1,800 a month and you and your spouse, partner or co-owner earn a combined gross income of $6,000 a month. That’s a housing ratio of 30 percent ($1,800/$6,000). Most lenders will consider that (and even slightly higher) as acceptable, provided your total debts are not too high.
Your Total Debt Ratio:
Of the two ratios, this is the more important. A lender will take your total housing expense and add all other recurring debt payments that you have, including credit cards, auto loans or leases, personal installment loans, student loans, child support and alimony payments.
Take the $6,000 gross income example above. If your total debt payments come to $2,460 a month, your DTI is 41 percent. That should be acceptable to most lenders. Debt payments of $2,700 would take your total debt ratio to 45 percent and probably make you borderline for many lenders. At 50 percent or higher, most buyers would be turned down for a conventional Fannie-Freddie loan, but some might qualify for an FHA insured-backed mortgage.
Mortgage Secret #2: Loan types matter a lot.
For most new buyers, the type of mortgage they choose will greatly affect what they can afford. Keep in mind that there are four major types of mortgages:
1. Conventional: loans intended to be sold to Fannie Mae or Freddie Mac, the giant mortgage investment companies. These loans generally require higher down payments and stricter underwriting standards than government agency-backed loans.
2. FHA: Federal Housing Administration-insured loans are designed for first-time buyers and those with less-than-perfect credit histories.
3. VA: Provided by the U.S. Department of Veteran Affairs, these guaranteed mortgages are reserved for active duty and retired military personnel.
4. USDA: Also called a Rural Development Loan, these mortgages are intended to serve buyers in rural and small towns, where credit availability can be tight.
FHA loans require a minimum down payment of just 3.5 percent for applicants with FICO credit scores above 580. (Below that, 10 percent down is mandatory.) FHA underwriting guidelines also are more generous than conventional Fannie Mae and Freddie Mac rules and will often allow 50 percent DTIs or even slightly higher if you’ve got strong “compensating factors,” like a lengthy stable employment history, high credit score, savings accounts, and other assets. However, FHA has recently raised its mortgage insurance fees significantly and may be more expensive on a monthly basis than conventional options if you’ve got plenty of cash to apply towards a down payment.
For those who qualify, VA and USDA loans can get you into the biggest loan for the least. Down payments can be as low as zero, and underwriting guidelines can be super-generous, especially if you qualify for a VA loan.
The Biggest Mortgage Secret: Automated Underwriting
Though most home buyers are unaware, the success of their mortgage applications — and thus their ability to buy a home — rests with two national online computer models that flash tens of thousands of “yes,” “no” or “maybe” responses to lender inquiries every day. One model is called Loan Prospector (LP) and is owned and operated by Freddie Mac; the other is Desktop Underwriter (DU) and is run by Fannie Mae.
Combined, these two giant agencies supply the bulk of mortgage money in the U.S. And their online underwriting programs are used by virtually all banks and loan officers to make initial assessments of the viability of mortgage applications, even if the loans are intended for insurance backing by FHA, VA or USDA.
This is how it works: Loan officers feed your basic information into an LP or DU. The underwriting engines use complex statistical algorithms to determine whether the total package — borrower credit reports, scores, income, assets, reserves, the amount of the proposed loan compared with the property valuation, debt ratios, types of debt the borrower has used in the past and the type of mortgage now being sought — deserves an approval for funding or not.
Automated underwriting can also increase your ability to buy a home because it searches for bright spots in your application that could counteract or outweigh negatives. It makes underwriting more flexible than a set of rigid rules. It’s the reason why a 45 or 50 percent DTI can get approved, even though the standard “rule” in Fannie Mae’s guidelines says 41 percent is the max.
Skilled loan officers can get your application approved through the DU or LP by adjusting the application “mix,” such as raising your credit score by having you move balances on certain debts or finding ways to raise your eligible income. One note of caution: Don’t allow yourself to commit to a loan amount that will strain your monthly budget. That was what got so many borrowers into trouble during the housing bust of 2007-2009.
Other key points
Income: Your eligible “income” may be more than what you think. It’s not just what’s on your W-2s. Say you make a little extra money from a side business or receive additional income via rents, royalties, regular investment income or capital gains, alimony or child support payments, an automobile allowance from your employer, or rent from boarders. These types of additional revenue are all potentially includable to boost your loan amount, provided that you can document them and they are stable and continuing. For older applicants, Fannie and Freddie both allow the use of Social Security income, regular income from IRAs, 401(k) plans, SEPs and Keogh retirement accounts under certain circumstances.
Credit Scores: Credit scores can be killers. Some lenders won’t approve applicants whose credit scores are below 640, 660 or even 680. If they do accept such scores, some lenders may hit homebuyers with heavy extra fees, even though they know the LP and DU will accept lower credit scores with compensating factors. Remember: there are dozens of credit score products on the market, but the only one that counts in automated underwriting is FICO. If your credit report was produced by any source other than FICO — even if it carried heavily promoted names like Experian, Trans Union, Equifax or FreeCreditScore.com — it’s not a FICO unless it says so and therefore won’t count.
Closing Costs: Don’t forget to factor closing costs into any calculations you make. Depending on where the property is located, it can account for anywhere from 2 to 5 percent of the total home purchase transaction. The good news is that Fannie Mae and Freddie Mac allow your builder or seller to pay up to 3 percent of the house price to lower your closing costs. FHA allows anywhere from 3 to 6 percent.
Now you know how much home a mortgage lender thinks you can afford. While that number is used, and you should not try to exceed it, it also makes sense for you to apply your own standards. Just because a bank says you can qualify for a given amount does not mean you should automatically borrow that full amount.
As the owner of both your income and debt, you can and should factor in your own thoughts. For example, perhaps you have a college education or a wedding to fund in the future for a child. While the underwriting processes described above won’t reflect such future expenses, you can and should consider them, as well.
With the advice above in mind, you should be better equipped to research and ultimately to decide what mortgage payment that you — and you lender — feel you can afford each month.
In addition to his articles for NewHomeSource, Ken Harney writes an award-winning, nationally syndicated column on real estate for The Washington Post Writers Group that appears in 90 newspapers.
Top 10 Reasons Home Buyers Prefer New Homes vs. Used
From knowing you’re the first homeowner to smelling that new home smell, there are a lot of reasons to prefer new. Here are ten!
Today’s new homes offer more benefits than ever before. Here’s a quick list of the Top 10 reasons why so many homebuyers prefer new homes to used houses:
1) Design Your Dream Home Your Way: Why settle for someone else’s choices when you can select your own cabinets, countertops, appliances, carpets, and flooring? While you’re at it, you can choose gorgeous bath and kitchen fixtures, lighting and other options that you love. Your new home will reflect your style, not someone else’s taste.
2) Choose a Floor Plan and Room Layout that Meets Your Needs: Want a master bedroom on the first floor? It’s yours. With massive his and hers walk-in closets? Done! Want high ceilings and a luxurious, resort-style master bath? Perhaps you’d like a sitting room with a fireplace in your owner’s suite or French doors that open to your private patio or the pool? It’s easy when you build your master suite your way.
3) All New, Under Warranty: A used home likely has tired products that may soon need replacing. Your new home — and the products that comprise it — are brand-new and under warranty. What’s the cost to replace a roof, appliances, countertops or a water heater on a used home? Those components of your new home feature the latest designs and building materials and should offer you years of comfort and enjoyment before needing replacement.
4) Energy and Cost Savings: Today’s new homes are far more energy efficient than homes built just five years ago. Versus homes built ten or 20 years ago, it’s game over, advantage new. Why settle for drafty, energy-wasting, single-pane windows in a used home? Many new homes offer double or even triple-pane windows. Special window coatings and inert gases between the layers of glass are often available, saving you even more energy and money in both heating and cooling season. In fact, a 2016 survey by the National Association of Homebuilders found that 90 percent of respondents listed Energy Star appliances as an essential or desirable feature in their most-wanted list.
5) Comfort and Indoor Air Quality: Today’s new homes meet stringent energy standards and codes not in place in the past. They combine high-performance energy efficiency with state-of-the-art ventilation and air filtration. The result is year-round, draft-free comfort and higher indoor air quality.
6) Low Maintenance: New cars today are computer-designed and computer-equipped. That’s why they perform much more reliable than a car that’s 15 or 20 years old. Homes are the same. Today’s new homes have open floor plans and high ceilings that reflect the way we live today. They’re also made of cutting-edge building products that require less care and maintenance. Another plus? The latest building systems and components are designed and engineered to work together.
7) Community Amenities: Many new homes are built in lavish master-planned communities with resort-style community centers, pools and clubhouses. Many new home communities also feature hiking trails, protected open lands and some of the best new schools and shopping near (or even within) your new home community.
8) Advanced Technology and Design: It’s possible to replace all of the single-pane windows in a resale home with today’s high-performance windows. It’s also possible to add insulation to a used home. However, it’s very expensive to replace dated appliances, cabinets and countertops in a used home — and you still won’t have the high ceilings you dream of on the first floor of an older two-story home. All are reasons to build your new home your way, to reflect the way you live today.
9) Safety: State-of-the-art circuit breakers. Electric garage door openers with infrared beams that stop if a tricycle or child is too near. High-efficiency furnaces and air conditioners that use the latest environmentally-friendly coolants. Cabinets, carpets, and paints that use fewer volatile organic compounds, so that you and your family can breathe easier.
10) That New Home Feel: A used home was someone else’s dream, not yours. It reflects their choices and family memories. You may learn to love avocado-green appliances (and you may be willing to scrub stained countertops or grease-encrusted ovens and cooktops) but more and more people prefer that never lived-in feel.
After all, when was the last time you went to a department store and selected used clothes? Or visited a car dealer and paid more for a used car than a new car?
Buying Versus Renting:
How to Choose the Option That’s Right for You
To rent or to buy, that is the question. When it comes time to make that decision, it takes some real self-assessment.
Homeownership has long been viewed as the American dream — and still is for many — but renting is legitimate, and often preferred, option for many.
Both have their benefits and a variety of factors can inform a person’s decision of whether to buy a home or to rent one.
Choosing which path is best requires some serious self-assessment of where you stand on certain key factors, such as the local housing market, your budget and lifestyle, the amount of flexibility you want and the level of commitment you want to put into a home.
Level of Commitment
“Homeownership is a rewarding proposition, but it may not always be the best thing for people,” says Kathy Braddock, managing director at real estate brokerage William Raveis New York City, adding that renting is a suitable option for many people, especially those who choose to do something different with their money and assets. “You have to do what’s right for you.”
If you are considering buying rather than renting, you need to ask yourself why you want to buy a house — do you view purchasing a house as a long-term residence or as an investment or income property?
Owning a home can be appealing because of the tax advantages involved, such as deducting your mortgage interest and property taxes from your income taxes, as well as the opportunity for appreciation in value, although that’s no guarantee, as the housing market crash in 2008 showed.
If buying a house to make it your primary residence, you should plan to stay at least five years, according to Braddock. “You need to stay at least that long to recapture the money you put into the purchase, from closing costs to moving and decorating.”
Budgeting and Affordability
Depending on your local market, the cost of homeownership versus the cost of renting may make your decision for you. Renting may be more economical in some areas, or the housing market combined with low-interest rates may make buying a home more appealing. Regardless, it’s important to make sure you know where you stand financially and what you can truly afford.
“Complete an average monthly budget,” says Liz Recchia, broker/owner of We Sell Real Estate, LLC, in Phoenix, Arizona. “Make sure you account for every dollar you spend.”
Recchia added that if you are thinking of moving from an apartment into the larger space of a home and yard, it’s important to take into consideration the extra expenses that can come along with such a move, including extra utility costs, new appliances or additional furnishings, lawn care equipment and other household tools, homeowners association fees and so on.
Recchia sits down with her clients before they ever go look at a home to ascertain what they want in a home, where they want to be, what they can afford, and future goals. “Figuring out what you want ahead of time can help you be rational about your purchase and happy with your decision,” she says.
A good way to check the feasibility of buying versus renting is to get a good lender to do a rent/buy analysis, Braddock says. She concurred with Recchia regarding the importance of figuring out how much disposable income you will have after monthly costs and advised not to forget important lifestyle expenses such as vacations, school tuition and so on. “Put pen to paper and decide what you cannot live without. You don’t want to be house poor for the long term. It can create a great deal of stress.”
If you decide to further investigate buying a home, you can have your real estate agent run a sample net sheet for the purchase price and loan type you are considering before you start looking at houses, Recchia says. A sample net sheet includes estimated closing costs, as well as estimated monthly payments including property taxes, homeowners insurance, principal, interest, HOA fees and so on.
“Frequently, buyers will look at that monthly number and realize they need to purchase a less-expensive house,” she says, adding that the next question people should consider is whether they can rent a similar house for less money. Or, even if owning means spending more up front, do own a home give them a greater sense of security?
Stability or Flexibility
When people think about the benefits of renting, an important reason that immediately comes to mind is flexibility. Some people don’t want to be tied down to one place for very long or like having the ability to relocate more easily if a job opportunity opens up in another city or state.
“Renting gives you both mental and physical flexibility,” Braddock said. “You’re not locked into anything.”
The issue of flexibility also ties into how much effort and money you want to put into a property. By renting, you generally don’t have to worry about repairs, plumbing issues, yard work or snow removal.
“Are you willing and able to invest time and money maintaining your own house? Some people just don’t have the desire to own property because they don’t want the responsibilities, and that’s OK,” Recchia says. “Decide if you want to spend that time and money on your house or if you would rather have someone else do that.”
But, if you’re in a good place career-wise and financially and have decided you’re ready to have a place that’s truly yours, the stability that comes with buying a home can be rewarding. It’s an opportunity for you and your family to put down long-term roots in your community.
If buying is right for you and you’re ready to start your new home search, check out New Home Source for the largest collection of newly built homes and new-home communities.