the amount of money you plan to use as a down
payment among other things.
The Debt-to-Income Ratio Explained
A big part of the
lender’s concern is your debt-to-income ratio. There are two calculations used
to determine this number:
Front-End Ratio
This calculation determines how much
of your pretax income will go towards your monthly mortgage payment. The
mortgage payment figure includes interest, principle, taxes, and insurance and
typically should not go over 28% of your gross monthly income.
Annual Salary x 0.28 / 12 (months of the year) =
Maximum Housing Expense
Back-End Ratio
This calculation determines the
amount of your total gross income that will go to pay all of your other
obligations, including the mortgage, other loans, child support, credit card
bills, and any other monthly debts. The figure should not exceed more than 36%
of your gross income.
Annual Salary x 0.36 / 12 (months of the year) =
Maximum Allowable Debt-to-income Ratio
Different lenders will have different requirements for
the debt-to-income ratio. For instance, conventional loans
— typically a
conventional loan from a bank or other mortgage lender — will require no more
than 26% to 28% of month gross income for housing costs and not more than 33% to
36% of monthly housing plus debt costs. With an FHA loan, the housing costs
should not exceed 29% of the monthly gross income and 41% of the monthly gross
income.
Other Factors Considered For A Mortgage
Approval
Other factors mortgage lenders will consider in their calculations for a
mortgage approval include the cost of your real estate taxes and homeowners
insurance. Property taxes can be determined by talking to your real estate agent
or contacting the local tax office for more information. Homeowners insurance is
a requirement for obtaining a mortgage and an estimate can be acquired from a
local insurance agent. Make sure you have an accurate quote from the agency to
get the right estimate.
Some areas will require additional coverage for
floods and other hazards, depending on the location of the home. Also,
if your down payment is less that 20%, you will be asked to obtain
mortgage insurance or to take out a piggyback loan
in order to reduce the initial loan to 80% of the
purchase price.
Before you begin looking or getting all excited about a
great house you have found on the market, take some time to get information
about prequalifying for a home loan. This may save you a lot of time and trouble
when house-hunting.
The fact is, you’ll be better prepared to offer a
respectable down payment when you know exactly how much house you can afford. Putting in some research,
preparation and time to understand your financial circumstances prior to buying a house will
allow you to negotiate a better deal and possibly make the home buying process move along
more smoothly.