| There are two basic formulas commonly
used by lenders to determine how much of a mortgage you can reasonably
afford. These formulas are called qualifying ratios because they estimate
the amount of money you should spend on mortgage payments in relation to
your income and other expenses.
It is important to remember that the following
ratios may vary from lender to lender and each application is handled on
an individual basis, so the guidelines are just that -- guidelines. There
are many affordability programs, both government and conventional, that
have more lenient requirements for low- and moderate-income families.
Many of these programs involve financial
counseling for low- and moderate-income people interested in buying a home
and in return, offer more lenient requirements.
Generally speaking, to qualify for conventional
loans, housing expenses should not exceed 26% to 28% of your gross monthly
income. For FHA loans, the ratio is 29% of gross monthly income. Monthly
housing costs include the mortgage principal, interest, taxes and
insurance, often abbreviated PITI. For example, if your annual income is
$30,000, your gross monthly income is $2,500, times 28% =$700. So you
would probably qualify for a conventional home loan that requires monthly
payments of $700.
Any expenses that extend 11 months or more into
the future are termed long-term debt, such as a car loan. Total monthly
costs, including PITI and all other long-term debt, should equal no
greater than 33% to 36% of your gross monthly income for conventional
loans. Using the same example, $2,500 x 36% = $900. So the total of your
monthly housing expenses plus any long-term debts each month cannot exceed
$900. For FHA the ratio is 41%.
One way to determine how much to spend for housing
is to compare your monthly income with monthly long-term obligations and
expenses.
When budgeting to buy a home, it is important to
allow enough money for additional expenses such as maintenance and
insurance costs. If you are purchasing an existing home, gather
information such as utility cost averages and maintenance costs from
previous owners or tenants to help you better prepare for homeownership.
Homeowner's insurance or property insurance is
another cost you will have to consider. The lending institution holding
the mortgage will require insurance in an amount sufficient to cover the
loan. However, to protect the full value of your investment, you might
want to consider purchasing insurance that provides the full replacement
cost if the home is destroyed. Some insurance only provides a fixed dollar
amount which may be insufficient to rebuild a badly damaged house.
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