If you’re trying to figure out how much house you can afford, it’s really a question of how much you can afford on your mortgage payment. If you had enough savings to pay cash, you’d probably already be out buying a house instead of looking at mortgages. Since you’re trying to get a mortgage, it all comes down to your mortgage to income ratio.
What Is a Mortgage Payment?
We’re not trying to insult your intelligence here, but if you want to figure out your mortgage to income ratio, you need to know what a mortgage payment is. You probably think you already know, but you probably aren’t aware of everything that goes into it. It’s not just paying off the principal on your loan, and it’s not just the principal plus interest either.
There are other things you have to add:
- Insurance premiums.
- Property taxes.
- HOA dues.
- Special assessments, such as paying your share for repaving the neighborhood roads.
- Any closing costs you rolled into the loan.
These are things you have to pay, or you lose your house. With insurance, if you don’t get it and your house burns down, you’re in serious trouble. The bank doesn’t want you to be in serious trouble or not pay your mortgage, so they make you get insurance. For taxes, dues, and assessments, if you don’t pay, the government or HOA can foreclose on your house. Again, bad things for you mean bad things for the bank.
But wait, there’s more. The bank doesn’t trust you to follow the rules on your own. Instead of paying for the above things directly, you pay extra on your mortgage into an escrow account. The bank pays your insurance, taxes, etc., out of that escrow account. This way, the bank knows everything necessary is getting paid, and there shouldn’t be any unpleasant surprises for them. So a mortgage payment that might be $1,000 for the principal and interest could be $1,500 all in. You’ll have to do the math on what those extra costs are where you want to buy a house since it varies widely by location.
How Do Lenders Determine Mortgage Loan Amounts?
Now it’s time to do some math to see how big a mortgage payment a bank will let you have. You need to know several variables on top of the mortgage to income ratio.
Gross Income
Gross income is your income before taxes. It can include salary, wages, self-employment income, Social Security benefits, alimony, and even that penny you get every month from your “high-interest” savings account. You’ll have to prove your sources of income, that they’re consistent, and that they’re likely to continue. This means letting your bank dig through your tax documents and bank statements.
Mortgage to Income Ratio or Front-End Ratio
Your mortgage to income ratio is what percentage of your income goes to paying your mortgage. If you’re paying $28,000 per year in mortgage payments and have a $100,000 salary, your mortgage to income ratio is 28%. Just so you know, 28% is the maximum for most loans. You can go up to 31% for FHA loans.
Debt to Income Ratio or Back-End Ratio
Your debt to income ratio is your total debt payments, including your mortgage, credit cards, car loans, student loans, and any other debt you have. If we take our example above and add $8,000 in additional debt payments for the year to that $28,000 in mortgage payments, your debt to income ratio is 36%. Thirty-six percent is typically the maximum lenders allow, but it’s not super set in stone. You might also see 40%, 43%, or 50% as the limit. It can depend on your lender, the type of mortgage you’re getting, and your credit score.
Credit Score
Like your mortgage payment, you’re probably saying you know your credit score, and we’re telling you that you probably don’t. If you think it’s what your bank tells you it is, it’s almost certainly not that. There isn’t just one FICO score. FICO makes different FICO scores for all sorts of things like credit cards, auto loans, mortgage loans, insurance policies, and more.
The short of it is that what makes someone more likely to repay a mortgage isn’t necessarily what makes someone more likely to repay a credit card. The only way to know your mortgage score is to request a mortgage score specifically.
Now how does credit score come into play if it wasn’t part of the math for the mortgage to income ratio or debt to income ratio? Your credit score primarily impacts your interest rate. A higher interest rate means that if you keep your mortgage payment the same, more of it goes to interest, so less of it can go to a house.
Down Payment
We’re pretty confident that you know your down payment is the money you pay upfront. There’s no trickery on this one. What you need to know about your down payment is that the banks don’t care about it except that it meets the minimum. It won’t affect (maybe just a tiny bit, but not really) the maximum mortgage payment the bank will let you have. The minimum down payment depends on your loan type and credit.
Let’s say you can qualify for a 3% down payment, and your bank is willing to loan you $100,000. Want a $100,000 house? You still have to put down $3,000 as the minimum down payment, and then you’re only borrowing $97,000. Want a $200,000 house? Well, the bank will still only lend you $100,000, so you’ll have to put down $100,000.
A larger down payment lets you afford a more expensive house with the same mortgage to income ratio. Alternatively, you can make a bigger down payment on a less expensive home to have a mortgage payment lower than the maximum the bank will give you.
See What You Can Qualify For
Are you bad at math or saying you know how to figure out your mortgage to income ratio, but you can’t read the bank’s mind when it “depends on the bank?” That’s where LemonBrew comes in. LemonBrew Lending makes it easy to find the right mortgage for you. Connect with a Loan Advisor today and find out if you’re approved and for how much.