How Much of a House Can You Afford

When deciding on how much of a home you can afford will depend on several factors.  The first is doing the math yourself, or having the bank do it for you.  Most people will have a banker do it because it's faster and easier for the client.  The downside to that is the bank will use a different formula than you will, and might qualify you for higher amount than you are comfortable with.

Lets look at both formulas to home affordability.

A bank does not necessarily look at the purchase price of the home.  Rather the bank will look at the projected mortgage size plus interest, and determine the monthly mortgage payment.  The bank will take that number and divide it by you monthly income.  This formula is called the Debt-to-Income Ratio, also known as DTI.  The DTI as two aspects to it.

The First aspect is the Front End DTI, or Housing Ration.  You take the projected monthly mortgage payment and divide that by your income.  The projected monthly mortgage payment will include,

• Principle,
• Interest,
• Monthly Property Taxes
• Monthly HomeOwners Insurance
• Association Fees.

There is a no maximum front end DTI, but most lenders want to be at 36% for conventional, and as high as 46% for FHA.

The Second Aspect is the Back End DTI, or Closing Ratio.  For this you have to add the housing expenses plus all your other debts combined.

Back-end ratio accounts for all of the following monthly obligations a home buyer may have :

• Monthly housing payment(s)
• Revolving credit card payments
• Monthly child support or alimony
• Monthly car payments for a car loan or lease
• Monthly payments to an installment loan such as a timeshare

In general, banks want to see a back-end ratio of 40% or less, however, having a DTI over 40% will not automatically disqualify your mortgage application. Many lenders allow up to 50% back end debt-to-income for Conforming Loan Amounts less than or equal to $417,000.00 in California.

One of the easiest ways to figure out your comfort level for a monthly payment is to work the math backwards.  For example you want your monthly payment to be $2500.00 a month for everything.  Everything is: Principle, Interest, Property Taxes, Homeowners Insurance and Mortgage Insurance if you are on a FHA type program.  Lets say you buy a house for $490,000.00 with a loan amount of $385,000.00 at 4% on a conventional loan.

Principle and Interest Payment is ...........................................$1838.05 a month
Home Owners insurance is .025% x 385000.00 or 962.50/12 = $80.21 a month
Property Taxes is $490,000 x 1.25% =$6125/12 or .................$510.42 a month
Your total monthly payment is .............................................. $2428.68 a month.

For an FHA loan of $385,000.00 at 4% you will have to add $433.13 in MI to the mortgage payment of $2428.68.  So your total is $2861.81 a month.  So with FHA you might want to borrow less money to compensate for the mortgage insurance. 

Mike Brown
Clear Lending
NMLS# 333411
Novato CA 94949