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. 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 x 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%.
Maximum
allowable monthly housing expense
26% - 28% of gross monthly income - Conventional
29% of gross monthly income - FHA
Maximum
allowable monthly housing expense and long-term debt
33% - 36% of gross monthly income - Conventional
41% of gross monthly income - FHA
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.
This information is adapted from "How to Buy a Home
With a Low Down Payment," developed
by the Mortgage Insurance Companies of America in cooperation
with the Extension Service
of the U.S. Department of Agriculture (USDA).
