Shopping for your first home can be an exciting and memorable time. Your mortgage lender, however, is always there to bring you back to reality. Lenders have very specific percentages of your income that they will allow you to spend on your mortgage to ensure that you are capable of paying back what you borrow.
The Credit Test
The most critical issue to mortgage lenders is whether you are capable of paying them back the money that you borrow. The first thing they look at is your repayment history by checking your credit scores. A history of late payments or missed payments may disqualify you for a loan. After all, if a friend borrowed $5 from you and never paid it back, you might not be so quick to lend them any more the next time they ask. If you pass the credit check, the lender then looks at your total income and any other outstanding debts.
Debt and Income Ratios
Lenders use debt and income ratios to determine the amount of money they will lend you. They allow a certain percentage of your pre-tax income to cover your housing expense, including principal and interest payments on the mortgage, real estate taxes and homeowner’s insurance. They also set a separate percentage of your income to cover any other outstanding debt such as car loans or student loans.
Lenders vary on the amount of income they allow for housing and debt expenses. A common ratio seen in conventional mortgages is 28 percent for your housing expense and an additional eight percent for other debt, making your total long-term debt percentage 36 percent. If you make $100,000 per year, a lender with a 28:36 debt to income ratio would allow you to spend $28,000 per year on mortgage, real estate tax and homeowner’s insurance and an additional $8,000 on other long-term debt. Despite the high percentage allowed for housing, the Bureau of Labor Statistics’ 2009 Consumer Expenditure Survey reports that couples spent roughly 16 percent of their income on housing.
A few government-backed programs allow higher debt to income ratios, according to Ginnie Mae. The FHA allows 29 percent of income for housing while the VA allows up to 41 percent. The FHA allows an additional 12 percent of income for other long-term debts for a total of 41 percent.
Think Before You Spend
While it may be tempting to take out the largest mortgage you qualify for, make sure to outline all of the costs of owning the home before committing. Older homes, for instance, may require more updating and incur more maintenance costs, while larger homes will cost more to heat and cool. Other costs to owning a home may include utilities, additional insurance requirements like flood insurance, homeowner association or condominium fees, mortgage insurance if your lender requires, landscaping and possibly higher commuter costs.
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