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Dale W Doughty, Jr.'s Blog

By Dale W Doughty, Jr. | Mortgage Broker
or Lender in Maine
  • How Do I Determine How Much Home I Can Afford?

    Posted Under: Home Buying in Maine, Financing in Maine  |  September 17, 2010 8:12 AM  |  376 views  |  No comments

    One of the most common questions I hear from prospective home buyers is “How Much Home Can I Afford?”  In years past that answer was often “as much as you want” followed by a Mortgage Broker structuring a creative loan package that made the dollar amount “affordable.”  Nowadays, lenders are taking a much more conservative and sensible approach.

     

    To determine how much home you can afford, you must first determine what your base gross income is (and unlike years past be able to document it).  Gross income is before taxes, insurance and whatever other deductions you have are made.  For example, if you earn $15 per hour and are guaranteed 40 hours per week your base income is $600 per week or $2600 per month.  If you also receive overtime and can consistently show overtime over a period of two years or more from the same employer you could add that in as well.  Calculating commission income and self-employment income requires taking a two year average from your last two years tax returns but the exact calculations involved are beyond the scope of this article.

     

    So, we’ve determined you earn $2600 per month.  Now we need to know what debt payments you currently have.  Let’s say you have a $200 car payment and a credit card with a $40 minimum payment.  Your current monthly debt totals $240/month.

     

    Debt-to-income (DTI) ratios are one of the biggest factors that lenders look at when determining whether or not to approve or decline a loan.  Your DTI is calculated by taking your total debt payments ($240) and dividing them by your total income ($2600).  So, in this case the DTI calculates to 9.2%. 

     

    When you finance a home you will have additional debt that is calculated into this ratio.  Your mortgage payment (principal and interest), your property taxes, your homeowner’s insurance, mortgage insurance (if applicable) and Homeowner Association Dues (if applicable) also get added in.  Once this is all added in your total debt ratio should not exceed 41% (although some lenders will go up to 50% or more in certain cases).  So, 41% of $2600 equals $1066.  This means the lender is comfortable with you having total debt payments of $1066 per month.  You already have $240 so that leaves $826/month that can be spent on housing expenses.

     

    Now you would need a calculator to continue but at 4.5% on a 30 year mortgage every $1000 you borrow will cost you $5.07 per month.  Let’s say you found a house you like and the listing reports that the taxes on the property are $2400 per year.  We can safely guess that homeowners insurance will be around $600 per year.  So, we need $3000 per year for the taxes and insurance which divided by 12 months equals $250.  That leaves us with $576 available for the mortgage payment ($826-$250=$576).  If we take the $576 and divide it by the $5.07 we get 113.609.  If we multiply that times $1,000 we get the maximum amount we can borrow on our new house, which is $113,609.

     

    How much you will need to put down will vary on several factors and there are many programs available that allow you to put as little as 0% down and some programs require as much as 20% down.

     

    If you have a lot of money in savings or have exceptionally high credit scores you may be able to buy a home with a higher DTI ratio and therefore be able to borrow $160,000 or more.  The best option is to contact a Mortgage Broker or Bankerbefore you start shopping and be pre-approved.  Once you are pre-approved by a lender they will issue you a letter that states how much you are able to borrow and what the conditions of your loan are.  This will allow you to confidently shop for the home of your dreams, knowing that your financing is in place once you find it.  Having a pre-approval letter also helps in the negotiation process because the seller knows that he or she is negotiating with a truly qualified buyer.

     

    If you are considering purchasing a home in the next year or so, now is the time to do it.  Aside from the fact that prices are down, rates are very low but creeping back up.  In the same scenario above let’s look at your affordability as rates move up:

     

    30 Year Mortgage at 4.0%   $120,755 (Where they were a few weeks ago)

    30 Year Mortgage at 4.5%   $113,609 (Where they are now)

    30 Year Mortgage at 5.0%   $107,263 (Where they were this spring)

    30 Year Mortgage at 5.5%   $101,408 (Where they were last September)

    30 Year Mortgage at 6.0%   $96,000    (Where they were September 2008)

     

    So, if mortgage rates moved up just 1 ½% in the next year you would have to lower the amount you could borrow by $17,000.  This could mean one less bedroom then you wanted, or a smaller yard with little room for the kids to play or not being able to find a home at all.

     

    Many lenders may charge an application fee or credit report fee up-front.  I choose not to.  For a free analysis and pre-approval contact my office at (207) 850-1007 or toll-free at (877) 440-2739.  You can also apply on line 24/7 by visiting www.ReliantSanford.com.

     

 
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