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Details
about the topic Of course, if you haven't already gone through
the basics of how much
home you can afford and haven't used the
calculator then you should go back there now before
reading any further -- the page you're on now is
the advanced stuff. Okay, on with the advanced stuff.... You'll remember the simple formula from the
previous page -- since you pay for your house
with a combination of a down payment and a bank
loan, the total of both is the cost of the
home: Down
Payment
+
Biggest Loan You Can Get
=
How Much Home You Can Afford You know how much you can afford for a down
payment, so that part's easy. (At least you
should know -- if you don't you should
probably figure that out before going any further.)
So that leaves us with finding the biggest loan we
can get. So really, the rest of this page is really
How much loan can I get? and not How much
home can I afford? To find how much home
you can afford just add the amount you can afford
for a down payment to the amount you can get for a
loan. We've left one thing out of our simple
equation above -- closing costs. You'll need to
either pay the closing costs from your savings
(lowering the amount you have available for a down
payment), or qualify for a loan that's a little
larger than the house you want to buy, and have the
closing costs added to the loan. Returning our focus to getting the biggest
loan possible, here are the things that can get us
a bigger loan: Let's look at each of these in
detail.
Higher
Monthly Income. Obviously the more you
can afford to pay for a home, the bigger the loan
you can get. The bank limits your monthly mortgage
payment (including taxes and insurance) to no more
than 28 to 36% of your monthly income. What
determines where you fall on that scale is the size
of your down payment and your credit score. In any
event, the higher monthly payment the bank
allow This 28 to 36% figure is called the Housing
Ratio. For example, if you make $3000/mo. and
the bank uses a housing ratio of 33% then the bank
figures you can afford $990/mo. in mortgage
payments ($3000 x 28%). Note that the amount you
can borrow is also limited by how much debt
you have. Just because the Housing Ratio says your
payments can be up to $990/mo., any debt you have
couldbring that figure down. We'll cover that later
on. Usually there's not much you can do in the
short-term about your income, but in one case there
is: Buy a duplex or a house with a separate
garage apartment that you can rent out. Then you
can count the amount you'll collect in rent towards
your income. Some lenders are finicky about
counting the rental income, but you can almost
certainly find one who will. Your chances improve
if the space is already rented and the renter has a
long-term lease. Being able to count this extra
rental income can help you buy a more expensive
home -- which will be a much better investment. Here's an example of how having a higher
income means a bigger potential loan amount.
These are estimates of loan amounts
available at various income levels,
assuming: $10,000 down, $500/mo. in debt, 7%
interest, 30-year mortgage, and 2% property taxes
and insurance.
Lower Monthly
Debt payments. The less money you
already owe, the bigger the loan you can get. The
bank limits your monthly mortgage payment
(including taxes and insurance) to no more than 36
to 42% of your total monthly debt, including your
mortgage payment. This figure is called the Debt
Ratio. For example, you make $3000/mo., have
$500/mo. in debt, and the bank uses a debt ratio of
38%. They limit your total monthly debt to $1140
($3000 x 38%). But you already have $500/mo. in
debt, so that means you have $640/mo. left over for
your mortgage payment. What determines where you fall on the 36 to 42%
scale is the size of your down payment and your
credit score. In any event, the higher monthly
payment the bank allows, the bigger the loan
they'll give you. Note that the amount you can borrow is
also limited by the housing ratio discussed
above. The bank figures your monthly limit using
the Housing Ratio, then they figure your limit
using the Debt Ratio, and they take the
lower of the two. Here are some examples,
with your monthly limit in each case
highlighted. Example #1 Example #2 Example #3 Example #4 Income $3000 $3000 $4000 $10,000 Debt $0 $175 $1000 $4000 Housing Ratio Limit (Income x
32%) $960 $960 $1280 $2800 Debt Ratio Limit (Income x 38% -
Debt) $1140 $965 $520 (-$200) Notice some interesting things about this. From
the first two examples you can see that you can
carry some "free" debt. With a monthly income of
$3000, it doesn't matter whether you have no debt
or $175/mo. in debt, you're limited to a $960/mo.
mortgage payment either way because the Housing
Ratio is the limiting factor. Now, if you had
more than $175/mo. in debt then your debt
would be the limiting factor. The next thing to see is that your net income is
irrelevent. You might think #1 and #3 are the same
because in each case the borrower has $3000/mo. in
free money after dealing with debt -- either $3000
in income and no debt, or $4000 in income less
$1000 in debt. But it doesn't work out that way.
When you have debt t This point is illustrated rather dramatically in
Example #4. This person is making a ton of money --
$10,000 a month. And with only $4000 in debt, her
net is $6000/mo., way more than our #1 or #2 people
make. Yet this person can't get a loan at all --
the bank thinks she's overextended because her
existing debt is too high in proportion to her
income. Here's an estimate of the loan you could
get at various debt levels, assuming $10,000
down, $3500/mo. income, 7% interest, 30-year
mortgage, and 2% property taxes and insurance.
Bigger down
payment. The more money you can put
down, the more the bank will loan you. Remember
our 28 to 36% Housing Ratio and our 36 to 42% Debt
Ratio? One thing that gets you towards the higher
end of the scale is a bigger down payment. (The
other main thing is your credit score.) Here are
typical ratios allowed depending on your down
payment: Down Payment Housing Ratio Debt Ratio Less than 20% 28-33% 36-40% 20% or more 30-36% 36-42% Yes, each value is still a range, because the
exact ratio is dependent on your credit score, and
how eager the bank is to loan money. The point is,
the ratios are a little higher when you have a
larger down payment. There's another reason a bigger down payment
gets you a bigger loan: When you put less than 20%
down you're required to get Private Mortgage
Insurance so the bank gets paid even if something
happens to you. By putting Putting 20% down could mean the difference
between getting a $117k loan vs. a $135k loan,
considering that you get a higher Housing Ratio
and Debt Ratio, and that you don't have to pay for
PMI. This estimate is based on $3500/mo.
income, little to no debt, 7% interest, 30-year
mortgage, and 2% property taxes and insurance. And finally, a bigger down payment lets you buy
a more expensive home, because you're adding a
bigger chunk of money to whatever loan you get from
the bank.
30-Year
Mortgage (vs. 15). The longer the
mortgage term, the more the bank will loan you.
For a given amount that you can pay per month, you
can borrow more money with a longer loan than with
a shorter loan. It works in reverse, too: For a given loan
amount, th This doesn't mean a 30-year loan is always the
best, because you wind up paying a lot more
interest on a 30-year loan vs. a 15-year loan. In
short, get a 15-year loan if you can, but certainly
take a 30-year loan on your dream home if that's
all the bank will give you. (And then try to pay
the loan off in 15 years.) There's more about 15
vs. 30 year loans on our loans
page. Getting a 30-year instead of a 15-year term
could mean the difference between getting a $94k
loan vs. a $120k loan. This estimate is
based on $3500/mo. income, little to no debt, 7%
interest, $10,000 down, and 2% property taxes and
insurance.
A better
credit score. The better your credit
rating, the more money the bank will loan you.
The bank uses your credit rating to help determine
what Housing Ratio and Debt Ratio
they'll allow you. (See above, under "Lower Monthy
Debt Payments". The amount of extra loan you can
get is similar to what you can get for making a
bigger down payment. Of course, if you have both a better
credit rating and you can put 20% down then
you can borrow even more.
Lower costs
for property taxes and insurance. The
less you have to pay for property taxes and
insurance, the more the bank will loan you.
Banks figure how much they'll loan you based on how
much money you can pay each month. The more money
that's needed to pay for property taxes and
insurance, the less that's available to pay the
bank for the loan, and the less money they'll loan
you. Taxes are generally charged as a percentage
of the value of a home. For example, if your
rate is 1.2% on 100% of a $100,000 home, you'll pay
$1200 a year in taxes, or $100 a month. (Another
county might charge 2.4% on 50% of the home value,
which works out to the same thing.) Tax rates vary
from county to county; call your county tax
assessor (or look them up online) to find the tax
rate in your area. Taxes can vary a lot --
0.4% in Honolulu, HI to 4.6% in Bridgeport,
CT.1 In addition to property taxes, you also have to
pay for property insurance. There again, rates vary
according to what part of the country you live in,
how much of a risk the insurance company
t When you add both insurance and tax costs
together you get the combined T&I rate that we
use on our calculator.
For example, if your property tax rate is 1.4% and
your insurance rate is 0.6%, then your combined
T&I rate is 2.0%. Having a 1.5% T&I rate vs. a 3.5% T&I
rate could mean the difference between getting a
$103 loan vs. a $127k loan. This
estimate is based on $3500/mo. income,
little to no debt, 7% interest, $10,000 down, and a
30-year term.
Conclusion.
The point of this page was to show you factors that
increase the size of the loan you can get from the
bank: If you can't borrow as much as you'd like, try
using the options above. Of the ones listed, what's
most within your control is lowering your debt
payments and improving your
credit score. To see the effects of most of
these variables you can use our How
much home can I afford? calculator. 1. This report from Tax
Foundation shows the
tax rates in the biggest city of each
state (page 6 of
report #106) (1999). Also potentially of
interest is Property
Taxes Per Capita by
State
(CNN). « Back: Down
payments « |
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y
behind those numbers, and helps you better
understand the factors influencing how much money
the bank will loan you. This won't necessarily help
you compute your borrowing power any better (that's
what the 
s,
the bigger the loan they'll give you.
he
bank thinks you're already stretched and they limit
how much you can borrow. In this case the person
making $1000/mo. less than the other person
can borrow nearly twice as much!
20% or more down you avoid paying PMI. The monthly
cost for PMI costs about 1/2400th the price of the
home. On a $120,000 home that would be about
$50/mo. PMI is automatically canceled when you've
made enough payments that your outstanding balance
is 78% or less of the purchase price. We have
e
loan with the longer term has lower payments than
the one with the shorter term.
hinks
your home is (wood houses burn better than brick
houses), and what kind of deal you can get from
your insurance company. Call a couple of insurance
companies to get estimates for insurance cost. In
the meantime you can use 0.6% as a rough estimate.
(e.g., Insurance could be $600/yr. on a $100,000
home.)