How Much Can You Afford?

Imagine you have just completed a search that included hundreds of hours of looking at the exteriors and interiors of houses. And finally, you have found the house of your dreams. Now imagine that this house of your dreams costs much more than you can afford. If you are house hunting and have not done an important piece of homework, you could be in for this kind of heartbreak. The first thing you need to know when shopping for a home is how much home you can afford!

Before you start shopping for a home, you need to know what kind of home to shop for. To determine that, of course, you’ve got to figure out how much you not only can afford but more importantly how much you'll be comfortable paying each month,  which can only be based on a specific purchase price, loan amount, the initial downpayment, interest rate and more importantly being formally preapproved not just prequalified!

Debt-to-Income Ratios

To determine your maximum mortgage amount, lenders use guidelines called debt-to-income ratios. This is simply the percentage of your monthly gross income (before taxes) that is used to pay your monthly debts. Because there are two calculations, there is a "front" ratio and a "back" ratio and they are generally written in the following format: 34/43.

The front ratio is the percentage of your monthly gross income (before taxes) that is used to pay your housing costs, including principal, interest, taxes, insurance, mortgage insurance (when applicable) and homeowners association fees (when applicable).

The back ratio is the same thing, only it also includes your monthly consumer debt. Consumer debt can be car payments, credit card debt, installment loans, and similar related expenses. Auto or life insurance is not considered a debt.

A common guideline for debt-to-income ratios is 34/43. A borrower's housing costs consume thirty-four percent of their monthly income. Add their monthly consumer debt to the housing costs, and it should take no more than forthy-three percent of their monthly income to meet those obligations.

The guidelines are just guidelines and they are flexible. If you make a small down payment, the guidelines are more rigid. If you have marginal credit, the guidelines are more rigid. If you make a larger down payment or have sterling credit, the guidelines are less rigid.

The guidelines also vary according to loan program. FHA guidelines state that ratios of 34/43 are acceptable.  VA guidelines do not have a front ratio at all, but the guideline for the back ratio is 41.

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