How Much House Can You Afford?
By, Nicole Crimaldi
Considering buying your first home in the next few years? If so, there are several things to think about well before you begin house hunting with your realtor. The most important question to begin with is, how much house can I afford?
Most lenders require that the mortgage applicant does not exceed a Front Ratio of 28% and a Back Ratio of 36%.
The Front Ratio is your proposed mortgage bill payment (including principle, interest, taxes and insurance- referred to as PITI) divided by your gross monthly income.
The Back Ratio is your total monthly obligations-to-income ratio. This is your gross monthly payments including Mortgage PITI divided by your gross monthly income. (Note: total monthly obligations do not include: utility payments, cell phone bill, day care, installment loans with 10 months or less remaining, and you only need to include minimum payments on credit cards.) So, for example:
1. If “Potential Homebuyer” makes $60,000 per year and has a car payment of $250, minimum credit card payments of $150, and a student loan payment of $300 per month, how much mortgage can she afford?
Front End Calculation:
$60,000/12= $5,000 gross monthly income
Mortgage Payment / 5,000 = 28%
Her front end ratio says she can afford a PITI mortgage payment of $1,400.
Back End Calculation:
($250 + $150 + $300) + Mortgage payment / $5,000 = 36%
700 + Mortgage Payment = $1,800
Mortgage Payment = $1,100
Since you must meet the criteria of both the Front and Back End ratios, she will likely get approved for a monthly payment of $1,100 including PITI.
2. So now Potential Homebuyer knows she can afford a payment of $1,100. How much of a loan could she get approved for?
Plug in the above figures (or your scenario) to this mortgage calculator. You can change the taxes, interest rate, down payment amount, mortgage term, association fees, etc. to get a more accurate view of your individual situation.
Note: In this example I used an interest rate of 6% for a 30 year mortgage, a down payment of $30,000, annual taxes of $3,000 and homeowners insurance of $300/year.
Under these terms, the calculator tells us Potential Homebuyer can afford a home of $167,603 and likely get approved for a mortgage of about $137,603 since she is putting $30,000 down. Now she will know what her max home price is when she starts working with her realtor.
Use this article and financial calculator to help you reach your goal of homeownership!