What can I afford?
That’s often a starting place for many when considering a home purchase. There are several ways to approach this question. Frequently I answer a question with a question – “what monthly payment is comfortable for you?”
Lenders use several payment calculations when determining a borrower’s approval for a loan but the best first step is looking at your own budget and evaluating what portion of it can reasonably be dedicated to housing expenses. You know your cash flow best and how you choose to spend your money.
The next step in determining a qualifying mortgage payment is evaluating a client’s debt to income ratio. Depending on the loan type different guidelines apply but as a general rule lenders look for a borrower’s total monthly debt payments to be <50% of their gross income. The expenses that are counted as debts are accounts like mortgages (to include the one on a new home if it’s a purchase loan), student and auto loans, credit cards, child support/alimony and monthly payments on other real estate owned. The types of expenses that don’t factor in are living expenses like utilities, childcare, etc.
What’s included in a lender’s housing expense calculation?
At a minimum it’s the loan’s principal & interest payment plus a 1/12th of the property’s annual tax and homeowner’s insurance bill. Other things that might be included are mortgage insurance, homeowner association dues and specialty insurance like flood insurance.
As a quick option for calculating payments based on current mortgage rates, you can divide the loan amount by 185 to get a ballpark principal and interest payment. However, mortgage payments are not one size fits all so it’s always best to get a specific quote from your lender when evaluating options.