How to quickly know how much house you can afford

Rules of thumb for home affordability
There are several easy rough estimates for how much you can spend on a home.

Choose a total payment that is close to what you spend now for rent
Select your maximum home price at three times your annual income
Choose a total housing payment that does not exceed one-third of your before-tax income
These “quick and dirty” calculations take about 5 seconds to complete. But our home affordability calculator helps you work this out either from a payment or income standpoint and gets you a much more accurate answer.

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Rules of thumb are just guesses
Rough estimates to know how much house you can afford are fairly easy to determine. But there are lender guidelines that can help you make a pretty accurate guess regarding what’s affordable and what isn’t.

You need to look at the DTI, aka debt-to-income ratio. This is a measure that lenders use to get a basic idea of how much home you can afford. It compares your recurring monthly debts with your gross monthly income — your income before taxes.

There are actually two of these — a front-end (or top-end) ratio and a back-end (or bottom-end) ratio.

Rough estimates and the front ratio
The front ratio is the amount of money you will spend for housing costs, divided by your gross (before tax) monthly income. “Housing costs” includes mortgage principal, mortgage interest, property taxes, and property insurance. The shorthand for housing costs is PITI.

How much home can you afford?

In some cases, the basic PITI calculation can also include homeowner association (HOA) fees, flood insurance, mortgage insurance, or rare items like PACE payments.

If you have a property where the insurance cost is $150 a month and property taxes are $300 a month, that’s a total of $450. If you want to borrow $250,000 over 30 years at 4.5 percent interest, the principal and interest (P & I) are $1,267 a month. Add $450 to that $1,267 and the PITI is $1,717 a month.

Ratios vary by program
What does $1,717 mean in terms of affordability? It depends on what loan program you get. With the FHA, you might be allowed a 31 percent front ratio but 33 percent if you apply for an energy-efficient mortgage. For a conforming mortgage — a loan that meets Fannie Mae and Freddie Mac standards — figure 28 percent.

For VA financing, the news is even better — there is no front ratio.

Understand, also, that lenders may be more forgiving of high front-end ratios if you have what is called “compensating factors.” For instance, your overall use of credit is low and you don’t have much debt.

Your credit score might be very high. Or you’re in a profession with increasing future earnings (congrats — you just graduated medical school). In most cases, lenders care more about your credit and total expenses than they di your front-end ratio.

The back-end ratio
We’ve looked at housing costs, but when lenders think of monthly expenses they also want to know about your other accounts, too. In particular, they’re interested in car loans, student debt, and credit card payments. (Note that ordinary living expenses like food and utilities don’t go into this calculation.)

Your back-end ratio is all the items of the front-end ratio, plus monthly payments for your car, credit cards, student debt, etc., divided by your gross monthly income.

If you want an FHA-backed mortgage, we already know that the front ratio limit is 31 percent in most cases. The back ratio ranges between 43 and about 50 percent.

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Many lenders impose 31/43 ratios. That means a maximum 31 percent front-end and 43 percent back-end.

If you have $5,939 a month in gross earnings, 43 percent of that amount will be $2,554. Subtract housing costs – $1,717 in this example – and $837 remains for other debts within the guidelines.

If $837 enough to cover car loans, student debt, and credit card payments? For some households yes, for others no. If the answer is no, then there are some steps borrowers can take to get their mortgage application passed.

Mortgage rates affect ratios
Because your monthly payment is a big part of your debt-to-income ratio, and because mortgage rates obviously affect that amount, your ability to buy depends somewhat on mortgage rates. the chart below shows how rates affect a family with $6,000 a month income and $300 a month in other payments.

rates-and-affordability

(Calculations performed by The Mortgage Reports Affordability Calculator)

home affordability rough estimate calculator

How to increase your home buying power
First, cut your monthly bills. See how each debt can be reduced or paid off. That leaves you more money for housing and probably improves your credit rating too.

Second, look for loans allowing higher DTIs — some allow up to 50 percent. A caution: These programs may look attractive, but they suggest a lot of monthly debt. That can be a problem if you lose a job or hours are cut.

Third, watch out for overlays. To avoid having to buy loans back if the borrower defaults, lenders may add stricter guidelines than the program requires.

How to buy a home with low income in 2018

A Fannie Mae loan might list 31/43 maximum ratios in its guidelines, but your lender might accept only 30/42. This means a borrower might not qualify with a conservative lender but might be okay elsewhere. If that’s a concern, ask upfront.

Fourth, if you’re VA qualified, there is just one ratio – 41 percent. In other words, there is no front ratio. Your housing can use 41 percent of your gross monthly income if you have no recurring debts.

Fifth, one of the easiest ways to reduce DTI ratios is to buy a less expensive property and borrow less.

Sixth, you can sometimes overcome DTI limits with compensating factors or exceptions. For details speak with loan officers regarding specific programs.

Don’t be “all thumbs”
Rules of thumb are fine when you’re buying thumbs. But you can do better by starting with our calculator and then connecting with a qualified mortgage professional.

by PETER MILLER

Peter G. Miller, author of The Common Sense Mortgage, is a real estate writer syndicated in more than 125 newspapers nationwide. Peter has been featured on Oprah, the Today Show, Money Magazine, CNN and more.