Before you can buy a home, you should ask yourself how much you can afford. Aside from having good credit, you must also show lenders your gross income and total debt obligations. You should have the right amount of surplus or breathing room in your budget if you want to buy a home. Calculate your income-to-debt ratio and then check with the lender if you qualify for a home mortgage.
Your income does not only include your regular job salary; it also constitutes bonuses, regular income from dividends and interest, assistance or support payments, such as alimony or child support, and payment from tips or commissions. Adding the total will give you your gross annual income, and then dividing by 12 will yield your monthly gross income.
Your monthly mortgage payments will include PITI (principal, interest, taxes and insurance). PITI is part of the formula lenders use when calculating your affordability ratios. Principal payments go toward paying the balance you owe for the house, the interest is the amount your lender will charge you for financing the loan; taxes are for your real estate property taxes that the government charges and the insurance is the homeowner's insurance (e.g., fire, flood and earthquake). In addition, lenders may charge you PMI (private mortgage insurance) if you can pay less than 20 percent down payment on the house. Most lenders include PMI in the monthly mortgage statement if you're unable to pay in one lump sum. Some buyers elect to pay taxes and insurance separately while others prefer to include them in one bill. In the latter's case, lenders pay the property taxes and insurance on behalf of the buyers.
Front-End Debt-To-Income Ratio
The housing expense (PITI), or front-end, ratio shows how much of your gross (pre-tax) monthly income would go toward the mortgage payment. Your monthly mortgage payment should not exceed 28 percent of your gross monthly income says the University of Maryland University College. Multiply your gross annual income by 28 percent (0.28), and then divide the result by 12 (months) to get the maximum amount for your monthly mortgage. For example, you're making $75,000 a year and you multiply by 0.28 (28 percent) yields $21,000. Divide $21,000 by 12 to yield $1,750, which is the maximum amount of monthly mortgage-related payments that you can afford.
Back-End Debt-To-Income Ratio
When calculating your back-end debt-to-income ratio, make sure to list your entire monthly debt obligation, including mortgage, car loans, credit card bills, student loans, child support and alimony. In general, you should have no more than 36 percent of your gross income to pay for your total debt obligations. Multiplying your annual salary by 36 percent (0.36), and then dividing the outcome by 12 (months) will yield your maximum allowable back-end debt-to-income ratio. Therefore, if you’re making $75,000 per year and you multiply by 0.36 (36 percent), the result comes to $27,000. Then, dividing $27,000 by 12 (months) will yield $2,200, which is the maximum amount of your total debt obligations.
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