How Lenders Determine How Much Home You Can Purchase
So, you want to know how much home you can afford. What I want to outline to you in this article is how lenders determine this. You don’t necessarily have to speak to a loan officer to find out.
Lenders use a term known as debt to income ratios. They use two of them. One is known as a front end ratio.
The first thing the lender determines is how much gross income you make on a monthly basis.
For FHA loans lenders like to see the ratio of the monthly payment of the house, including taxes and insurance, not exceeding 29% of your monthly gross income.
A thirty-three percent front end ratio is generally used as a basis for conventional loans.
To qualify for either type of loan you must qualify not only on the front end ratio but the back end as well.
The back end ratio is a compilation of all your monthly debt payments. Add your new house payment to those monthly debts and this percentage is your back end ratio.
For FHA this ratio is best not to exceed 41%. For conventional loans it is 38%.
It is pretty easy to determine your monthly debt payments. What isn’t so easy for the non-mortgage loan officer to determine is the actual income.
Now, you may be lucky and get a salary. Well heck, just divide by 12 and you have a monthly income.. It’s not so easy for the rest.
It runs the gambit from construction workers who make money based upon the economic environment, to hourly workers, to commissioned based folks who write off everything under the sun on their returns.
Others work seasonally and the list goes on and on.
A good rule of thumb if you are basically self employed or receive most of your income via commission is to average your last two years tax returns.
Most hate me for saying that to them, but lenders look at facts when determining how much they will lend to you. Especially today with all the financial turmoil.
Once you come to some conclusion here you should still seek the advice of a good mortgage lender. I wish you the best in your next home purchase.
