Setting a Budget – How Much House Can You Afford?
Setting a Budget – How Much House Can You Afford?
The first step is talking with a mortgage broker. Even if you can’t get approved for a mortgage right now, he can still help you determine how much you can get approved for later. He has formulas that calculate the maximum amount you can qualify for in a mortgage. These formulas are based on your income and debts. Most mortgage lenders use a debt-to-income ratio (DTI) of 28/36 and FHA limits are typically 31/43. Let me explain what those numbers mean.
Budget Planning
The first number in the debt-to-income ratio (DTI), 28 (or 31 for FHA) is called the front ratio. The front ratio is the percentage of income that can count towards housing costs, or PITI, which are Principal, Interest, Taxes and Insurance. That means that 28% (or 31% for FHA) of your gross income (before taxes are taken out) can count towards these costs.
The second number, 36 (or 43 for FHA) is called the back ratio. The back ratio includes the amounts from the front ratio (PITI) plus any other recurring debt payments, such as car loans, credit cards, student loans, child support, alimony or legal judgements. This does not count things like groceries, utilities and so forth. Again, this means that 36% (or 43% for FHA) of your gross income can count towards these costs.
Let’s take a look at an example. Suppose your annual household income is $60,000 per year. You divide that amount by 12 months, which equals $5,000 per month (before taxes). Here is how we calculate DTI.
Front Ratio
$5,000 gross monthly income X .28 (the front ratio) = $1,400
$5,000 gross monthly income X .31 (FHA front ratio) = $1,550
Back Ratio
$5,000 gross monthly income X .36 (the back ratio) = $1,800
$5,000 gross monthly income X .43 (FHA back ratio) = $2,150
Excerpt from Rent-to-Buy: Your Hands-on Guide to BUY Your Home When Mortgage Lending is Tight.