What Can We Afford

In section one, we discussed Want vs Need and we now have some basic criteria of the Home we would like. We now need to review two things. 1. If the Home we want fits into our budget. 2. If the Lender agrees that our budget fits into their risk profile.  Lets break it down.

1. BUDGET: This sounds simple enough but if you live at home, rent or are combining incomes or households, there may be a lot of changes to your finances that we will need to consider.
First thing is we need to look at our current situation. This is a really simple worksheet for you to download ” My Budget Worksheet” or a free editable template download if you have Microsoft Excel “My Budget Template”

Some questions you may want to consider?

1. Do I need to review my life, car and home insurance?

2. Will I be gaining or losing a wage tax?

3. How will any tax deductions for property taxes or interest affect my take home pay?

4. How much of the mortgage payment goes to build equity in the home?

The goal of a budget is to come up with a monthly payment that is realistic and fits into your comfort zone. No one wants to be house poor but stretching a little, especially if you plan to own for a while, can be a sound investment. For example, if you currently rent a 2 bedroom townhouse at $1,200 per month and would like to purchase a 3 bedroom single for $1,100 per month that may not be realistic. After factoring in tax savings and equity you may find that a $1,500 payment leaves you close to the same net income per month as your $1,200 rental. You should make the final call on a mortgage payment that you are comfortable with. Just because the bank will approve it doesn’t mean you should accept it. For illustration purpose lets assume $1,500. The Lender will refer to this as a PITI payment. This stands for Principle, Interest, Taxes and Insurance plus any PMI (Private Mortgage Insurance) MIP (Mortgage Insurance Premium, Government Loan) along with any Association fee. To calculate a mortgage amount we will need to make some estimates and remove T & I from the PITI payment. Let’s assume taxes at $350 per month and home insurance at $50 per month leaving us $1,100 remaining for P & I assuming no mortgage insurance or association fee.

RATE	TERM	P & I	LOAN
4.000%	360	$1,100	$230,407
4.500%	360	$1,100	$217,097
5.000%	360	$1,100	$204,909
5.500%	360	$1,100	$193,733

As you can see the interest rate can play a huge part in how much mortgage a set payment will purchase. We will discuss later the factors that may determine the Rate. Let’s see what effect, taxes and association fees may have. Let’s assume taxes at $3oo per month and home insurance at $0 per month assuming no mortgage insurance but with a Condo association fee of $185 leaving us $1,015 remaining for P & I

RATE	TERM	P & I	LOAN
4.000%	360	$1,015	$212,603
4.500%	360	$1,015	$200,321
5.000%	360	$1,015	$189,075
5.500%	360	$1,015	$178,763

So we can see that taxes and Association fees can also have a large effect on your loan amount. What about Mortgage Insurance? Let’s assume taxes at $350 per month, home insurance at $50 per month and $150 per month for mortgage insurance, no assoc fee, leaving us $950 remaining for P & I

RATE	TERM	P & I	LOAN
4.000%	360	$950	$198,988
4.500%	360	$950	$187,493
5.000%	360	$950	$176,967
5.500%	360	$950	$167,315

Is that crazy or what? A $1,500 per month payment with just a few adjustments goes from $167,000 to $230,000!  Just remember… Rate Matters… PMI is Costly… Taxes and Assoc Fees effect PITI.

2. LENDER’S RISK: Lenders don’t care about your house other that it’s collateral for the loan… They don’t want the house! Lenders care about Risk. The Risk of you not paying them back! Lenders access your payment risk using a RATIO (percentage of your gross income before taxes) The PITI+ payment they would like to see is around 33%. $4,545 per month income would = $1,500 per month. This is called the front Ratio. The BACK ratio is PITI+MONTHLY DEBT. The Lender would like to see the BACK ratio around 38% of gross income. Some loans may be approved with 45 Front and 50 Back Ratios with certain products or compensating factors. The Lender will use the MONTHLY DEBT that shows on your credit report. Things like car insurance, medical payments, daycare, Church, utilities, 401k, etc. that are not reported are not calculated in your ratios…

As you can see there are many variables and every borrower has unique circumstances. Be careful of online calculators! Most are incomplete and a slight change of numbers can really mislead you.

Gross Monthly Income:__________x .0036 = PITI+ (front)

Gross Monthly Income:__________x .0041 = PITI+ (-DEBTS)= (back)

WARNING: If your back is lower than front then you may be debt heavy! use back for PITI+ to qualify. Please see credit scoring before paying off any debts to qualify!

Are these numbers in line with where you want your PITI+ payment and are they in your comfort zone?

You should now have a number for your payment… Remember RATE MATTERS!! Some of the biggest factors that will determine how much you can actually afford is your RATE/PRODUCTS that you qualify for and this will largley be determined by your credit score.

Check out “CREDIT SCORING”