If you are planning on applying for a mortgage in the near future, you may be wondering how the bank determines how much money to lend you. Following are some of the different parameters lenders use, although each lender has access to different loan programs and may use other metrics to measure how much of a mortgage you can afford.
Housing Expense Ratio
A guideline for reverse-engineering how much of a payment a buyer can handle is by looking at their total gross income per month and allocating 28% of that income maximum to be spent on housing expenses. Therefore, if a person’s total gross income per month was $5,000, the lender would indicate that up to $1,400 per month could be allocated to housing. Note, some lenders allow for a greater housing percentage – up to 33%.
Housing expenses include mortgage payment, hazard insurance, property taxes, private mortgage insurance (if you have less than 20% down payment) and even homeowner or condo association expenses. These are variable per property, so although the lender may have an idea of what you can afford by looking at your income, final approval would be to look at how those total housing expenses of the unique property come together.
Total Expense Ratio
Lenders don’t want borrowers to be spread too thin, so they typically also look at a borrower’s total expenses in terms of monthly obligations. These include things such as car payments, credit card payments, student loans, and other installment payments. Some lenders cap housing and other debt that requires a monthly payment at 36% (although some lenders will allow up to 43%).
Bringing it Together
How does the above come together? Using the more conservative numbers of 28% for housing expenses and 36% total of all expenses combined, here are three annual salary examples:
|28% max housing allowance||$583.33||$1,166.67||$1,750.00||$2,333.33|
|36% max all monthly payment debt including housing||$750.00||$1,500.00||$2,250.00||$3,000.00|
Some other things to keep in mind
Your credit score will also determine if you can borrow, how much you can borrow, or the interest rate you are charged. Other parameters such as the type of loan, the type of property, the term of the loan and more can affect the interest rate as well as the corresponding monthly payment which can change the ratios.
How should you prepare for your next loan? Step one is to meet with a lender who can analyze your situation and have you make any tweaks to get your ratios in a better position. That might mean paying off a car loan or a using funds to pay off a credit card. But these ratios are carefully calculated, so meet with a lender first. You don’t want to pay off a credit card and learn that you really should have used that money for the down payment instead.
Ready to meet with a lender? Reach out! I have several that I can refer you to.