- Income. First, add up the income that will be used to qualify for the mortgage, including bonuses and commissions. A simple method is to divide your annual pre-tax income by 12 to produce your monthly gross income. Make sure you have the documentation to prove every source of income; otherwise it cannot be counted when you meet with a mortgage lender.
- Debt. Add all the payments you make each month for car loans, credit cards, student loan payment and any other debt. Based on your income, there are limits on how much debt you'll be allowed to carry, including your mortgage. These debts will limit how much mortgage you can borrow.
- DTI ratio. When a mortgage lender calculates your level of debt based upon how much money you make, it is known as your “debt-to-income (DTI) ratio.” Debt-to-income ratios are the province of mortgage calculators. One important ratio, referred to by mortgage professionals as your "front-end" or "top-end" ratio, is calculated by taking your proposed housing expense divided by your gross (before-tax) income. Most mortgage calculators set 28 percent as the desirable value for this ratio, and the front-end ratio determines how much of your monthly pre-tax income can be used for the principal and interest payment on your mortgage.
The other ratio involves all of your loan payments – your housing expenses (including any HOA fees, if applicable) and your total monthly debts (but not utilities or other living expenses) -- divided by your gross monthly income. Home affordability calculators frequently set this number at 36 percent. This is called your "back-end" or "bottom-end" ratio. Note: Qualified mortgage standards allow for back-end DTIs of up to 43%, and you can change the back-end ratio the calculator uses. - Monthly obligations. While your mortgage lender cares about your car payments and credit card debt - and other debts you are required to pay - they really don’t care whether you have cable TV, the latest iPhone or even that you eat on a regular basis. Those monthly expenses are up to you to manage, and cable, smartphones and a few trips to the grocery store can easily add up to several hundred dollars each month.
- Down payment. The minimum down payment amount for an FHA loan is 3.5 percent; for conventional loans, the minimum is 3 percent for certain buyers and 5 percent for most buyers. Certain loans, such as VA loans or USDA-backed loans, do not require a down payment, but there can still be reasons to make one.
- Taxes. Today, it’s easy to get an idea on a home’s property taxes by looking at the listing online. You can also get in contact with the county tax office or ask a local Realtor to investigate for you. Most homeowners will have their property taxes paid from an escrow account attached to their monthly mortgage payments. One percent in taxes is equal to $1,000 per year for a $100,000 home.
- Insurance. Lenders require homeowners insurance to cover your property. Contact an insurance company or ask a Realtor to estimate your homeowners insurance costs which will vary according to the type of property, cost and features of the home, and its location. To get a rough idea, you can ask a family member or friend what they pay for insurance (if their home is similar to the home you are interested in buying).
- Homeowners association dues. If the property you purchase includes monthly HOA dues, don't forget to include those fees in your required monthly housing payments.
- Mortgage insurance. If you make a down payment of less than 20 percent on a conventional loan, you will need to pay for private mortgage insurance. Use HSH’s PMI calculator to get an accurate monthly cost estimate for PMI. For FHA loans, there is an upfront and annual mortgage insurance premium.
- Interest rate. You can check today's mortgage rates at HSH.com, but remember that your interest rate will depend on your credit score, the type of property you are buying, the type of mortgage you choose and the choices you make regarding paying fees and points. A lender will be able to give you a customized mortgage quote given your situation. And if the rate you can qualify with today seems high, you may be able to refinance at some point in the future.
- Loan term. While many buyers opt for a 30-year home loan, if you can afford higher monthly payments, you may want to consider a shorter loan term or even a different loan type. Shorter term loans have lower interest rates and cost you less over the life of the loan.
For an example calculation, lets assume you are a first-time homebuyer, have a very good credit score, a $60,000 annual household income, $250 in monthly debt payments, $20,000 to use as a down payment, property taxes of 1.25% of the purchase price you can qualify for and annual homeowner's insurance premiums of about 0.5% of the home's value.
With a 4% mortgage interest rate and a 30-year fixed-rate mortgage term, and using a 28% housing ratio, this means you can utilize $1,400 per month for Principal, Interest, Taxes and Insurance; with your down payment of just 8.89% of the home purchase price, Private Mortgage Insurance costs will also be included in that $1,400 figure.
$1,400 per month qualifies to borrow a loan amount of $204,913; add your $20,000 down payment to this, and you can purchase a home of $224,913. Of course, you’ll still need cash for reserves and to cover the loan’s closing costs.
Your debt-to-income ratio as a percentage of your income is low enough so that the back-end "cap" of 36% of your gross monthly income doesn't come into play. In fact, the 36% cap means you can carry as much as $400 per month in debts and still qualify for the amount above.
If your DTI is above 36%, don't worry. Fannie Mae and Freddie Mac are now backing loans for borrowers with back-end debt ratios of as much as 50%. While less debt is better, more doesn't necessarily mean you can't qualify for a mortgage large enough to buy a great piece of real estate that you can call home.