#2 -
HOW MUCH HOUSE CAN YOU AFFORD?
Here’s How to Find Out
Purchasing a home, especially your first home, can be an experience loaded with frustrations and uncertainties. One of the first steps in this often confusing process is to figure out how large of a home loan you can qualify for – realistically. The loan process is actually a fairly simple one, once you know what factors a lender will need to consider in order to calculate your loan. These are:
1. Your total GROSS monthly income.
2. Your total current, monthly long-term debt payments (for example, car payments)
3. Current interest rate for the type of loan desired, for example, a “30 year fixed rate loan.”
The lender will need to know your GROSS Monthly Income, or GMI - not the amount of “take-home pay” in your paycheck. The reason the GMI is required instead of your paycheck amount is because the lender’s qualifying ratios already take into account the amount deducted for federal taxes, state taxes, etc.
The next thing your lender will need to know is your total LONG TERM monthly debt. This amount would include any car payments, personal loans or student loans, credit card payments, etc. - anything with pay off dates longer than 10 months in the future. To get a ballpark figure of your long-term credit card debt, you can either add up the minimum payment amount on each credit card’s monthly statement, or calculate an estimate by taking 5% of the total outstanding credit card debt.
If you use a lender in your local area, they would probably be more willing to provide the FACTOR necessary to calculate the largest home mortgage available to you - based on the current market interest rate. In other words, the factor for a 6.5 % fixed rate 30 year mortgage is 6.33. What that figure means is, for each $1000 you borrow every month, you’ll have to pay the mortgage company $6.33. So, the principal and interest payment for a $100,000 mortgage would be $633.00 (100 x $6.33) per month if the current interest rate was 6.5 %.
Now that you know what a lender will look for when they try to figure out how much house you can afford, you can identify the “Qualifying Ratios” the lender will use in approving your mortgage. “The Standard Qualifying Ratio for Conventional Loans” is 28/36. This means that the lender will limit your monthly Housing Expense to 28% of your Gross Monthly Income, and your Total Monthly Debt (Housing + Long-term Debt) to 36% of your Gross Monthly Income. “Housing Expense” is considered to include: Loan Principal & Interest, Property Taxes and Homeowner’s Insurance, also known as “PITI.”
Because housing is more expensive in Hawaii, it typically takes more of your overall monthly budget than most housing on the mainland. Consequently, a local lender will typically ignore the more restrictive 28% Housing Expense Ratio and only look at a potential buyer’s Total Debt Ratio. Also, the lender will most likely use a 40% Total Debt Ratio figure as opposed to the more restrictive 36%. For example, a couple earning a total Gross Monthly Income of $5,000 will have $2,000 allocated for Total Debt ($5,000 x 40%). This means that, if they have less long-term debt, they’ll have more money available for Housing Expense, and therefore the larger home loan they can qualify for.
To illustrate the above, and using the $5,000 total monthly Gross Income figure, a couple with $400 per month long-term debt and $400 per month of Taxes & Insurance would qualify for a mortgage of approximately $190,000 ($2000 - $400 - $400 Taxes & Insurance = $1200 divided by the 6.33 factor).
The same couple with zero monthly debt, on the other hand, would qualify for a mortgage of approximately $252,800 ($2000 – $400 T&I = $1600 divided by the 6.33 factor) - a significantly higher loan amount. Another way to look at the above figures, given a 6.5% interest rate and a 30 year fixed rate loan is that, for every $100 of monthly long-term debt you have, you lose approximately $16,000 of “mortgage-ability”, aka; how large a loan you can qualify for.
So, for every $100 of credit card debt you have at 18% interest (which is NOT a tax write off) you lose out on approximately $16,000 of potential mortgage at 6.5% (which IS a tax write off)! This is a no-brainer – pay down those credit cards! It’s also a good idea to get rid of the car payments if possible. Get a more affordable car that you can pay off completely instead of making those monthly payments.
Considering the example given above, think about how much that $350 per month auto loan or credit card debt payment is costing you. You could have an additional $55,300 mortgage benefit towards buying your own home. Add that to the amount you can qualify for with your income level, any savings you may have for a down payment, and home ownership may start making a lot more sense for your future.
Too many people in the U.S today pay rent, which is in effect - paying their landlord’s mortgage, PITI, etc. The landlord gets to enjoy the benefits of tax write-offs, ownership equity and price appreciation. Your rent money is gone every month into the landlord’s pocket while they build equity in their own property. Doesn’t it make more sense to check out the how you could be applying that same rent money towards your own home?
Do the math for yourself, and decide if the time is right for you to take the first step towards your own home. If you have any additional questions or concerns that we can assist you with, please feel free to contact us – we can help!
I hope this information was helpful to you! Aloha and Take Good Care!
Jay J. Spadinger, REALTOR®, Broker-in-Charge, Accredited Buyers Representative,
akahi@jayhawaii.com
In the next post, we’ll be going over a few additional things that can affect your ability to get approved for a loan, specifically:
1. Your Employment History
2. Your Credit History
