How big a mortgage can I afford?
What house can I afford? How much can I borrow?
If you thinking about buying a house or an apartment, and you are new to the game, then one of the first things you need to figure out, is big a mortgage a lender is likely to give you. Our mortgage calculator (on our HOME page) will give you a quick answer to what your income and economic status will allow you to borrow for a house.
But how do the mortgage lenders actually conclude, which mortgage size you are likely to afford? This article will give you some insight into their thinking.
First of all, your gross income a deciding factor to how much of a mortgage you will be able to afford. To be precise, how much you earn vs how much you owe will be the the overshadowing factor in a lenders eyes.
First, determine your gross monthly income. Any regular and recurring income is applicable. However, if you can’t document the income or it doesn’t show up on your tax return, then you can’t use it to qualify for a loan.
You can, though, use unearned sources of income, like alimony or lottery payoffs. And if you own income-producing assets such as real estate or stocks, the income from those can be estimated and used in this calculation.
Next you need to calculate your monthly debt. This includes all monthly debt obligations like credit cards, installment loans, car loans, personal debts or any other monthly obligation, such as alimony or child support. If it is revolving debt like a credit card, use the minimum monthly payment for this calculation. If it is installment debt, use the current monthly payment to calculate your debt load. And you don’t have to consider a debt at all if it is scheduled to be paid off in less than six months. Add all this up. This figure is your monthly debt service. In our calculator, you can show this amount as a lump sum.
In general, most lenders will not allow you to take out a loan that will overload your ability to repay everybody you owe. Although every lender has slightly different formulas, here is a rough idea of how they look at the numbers.
Typically, your monthly housing expense, including monthly payments for taxes and insurance, should not exceed about 28 percent of your gross monthly income. If you don’t know what your tax and insurance expense will be, you can estimate that about 15 percent of your payment will go toward taxes and insurance.
The remainder can be used for principal and interest repayment.In addition, your proposed monthly housing expense and your total monthly debt service combined cannot exceed about 36 percent of your gross monthly income. This is called the debt-to-income ratio. If it does exceed it, your application may exceed the lender’s underwriting guidelines and your loan may not be approved. Depending on your individual situation, there may be more or less flexibility in the 28 percent and 36 percent guidelines, fore example if you can afford a large cash down payment.
When reviewing mortgage applications, lenders base their decisions largely on the potential borrower’s credit history. Each time a lender draws an applicant’s credit history, they run it through a program that generates a FICO Score. It is extremely important that you have no current late payments. These are more detrimental to a loan application than record of an old bankruptcy case, if perfect credit has been maintained since the bankruptcy. Keep in mind that paying off credit cards with recent late payments will not fix your credit history.
Factors that Affect FICO Scores:
- Tax liens
- Delinquent payments
- No recent credit card balances
- Numerous recent credit inquires
- Legal judgments against the borrower
- Too many or too few revolving accounts
- Limited credit history (too short in length)
- Balances on credit that are near the maximum
- Numerous new accounts opened within a 12 month period
- Too many mortgage lenders running your credit reports
- Making any major purchases while looking to buy a property (e.g. vehicle purchases).
FICO scores are, essentially, just guidelines, and don’t mean that you cannot be approved even if your FICO score is low. There are other factors that can affect underwriting decisions based on credit worthiness. Some factors that might persuade an underwriter to be more lenient towards granting a loan to a borrower with a lower FICO score include:
- A larger down payment
- Low debt-to-income ratios
- Excellent money saving history
- Reasonable explanations for negative items on a credit history
Some lenders have a base loan price, but will reduce the points on the loan if the credit score is above a certain level, while Other lenders may decide to add points or costs onto the base price if your credit score is below their preferred score.
FICO Score Chart With Typical Mortgage Rates:
|FICO Score||Grade||Typical Mortgage Rates*|
|700-719||Very Good||A + 0.13%|
|675-699||Good||A + 0.65%|
|620-674||Fair||A + 1.80%|
|560-619||Bad||A + 4.30%|
|500-619||Very Bad||A + 5%|
Get a Co-signer:
Also, if a wealthy relative is willing to cosign on the loan with you, lenders will be much less focused on their strict guidelines.Remember that there are hundreds of loan programs available in today’s lending market and every one of them has different guidelines.In addition, there are a number of factors within your control which affect your monthly payment, like choosing an adjustable rate loan, which has a lower initial payment than a fixed rate program. As mentioned, a larger down payment will also lower your projected monthly payment.
Don’t be discouraged if you cannot afford your dream home straight away. Save up for a larger down payment and try to pay of some of your existing debt first.