DebttoIncome
Ratios
To
determine your maximum mortgage amount, lenders use guidelines called
debttoincome ratios. This is simply the percentage of your monthly
gross income (before taxes) that is used to pay your monthly debts.
Because there are two calculations, there is a "front"
ratio and a "back" ratio and they are generally written
in the following format: 33/38.
The
front ratio is the percentage of your monthly gross income (before
taxes) that is used to pay your housing costs, including principal,
interest, taxes, insurance, mortgage insurance (when applicable)
and homeowners association fees (when applicable). The back ratio
is the same thing, only it also includes your monthly consumer debt.
Consumer debt can be car payments, credit card debt, installment
loans, and similar related expenses. Auto or life insurance is not
considered a debt.
A common
guideline for debttoincome ratios is 33/38. A borrower's housing
costs consume thirtythree percent of their monthly income. Add
their monthly consumer debt to the housing costs, and it should
take no more than thirtyeight percent of their monthly income to
meet those obligations.
The
guidelines are just guidelines and they are flexible. If you make
a small down payment, the guidelines are more rigid. If you have
marginal credit, the guidelines are more rigid. If you make a larger
down payment or have sterling credit, the guidelines are less rigid.
The guidelines also vary according to loan program. FHA guidelines
state that a 29/41 qualifying ratio is acceptable. VA guidelines
do not have a front ratio at all, but the guideline for the back
ratio is 41.
Example:
If you make $5000 a month, with 33/38 qualifying ratio guidelines,
your maximum monthly housing cost should be around $1650. Including
your consumer debt, your monthly housing and credit expenditures
should be around $1900 as a maximum.
Step One  Calculating Your Monthly Income
When
a loan officer prequalifies you, he works backwards to figure your
maximum mortgage amount. You can do the same thing. The first step
is to determine your monthly income. It isn't quite as easy as it
sounds. Lenders only count income they can document through paperwork.
If
you are a salaried employee, and don't earn bonuses, it's easy.
Get out your paycheck. If you get paid twice a month, multiply by
two. If you are paid every two weeks, then you multiply by 26 (the
number of pay periods in a year) and divide by twelve. Unless you're
a teacher. Teachers don't always work year round and they have special
rules.
If
you are an hourly employee who works a straight forty hours a week
and don't earn overtime income, then it's easy, too. Look at your
paycheck, multiply your hourly rate by 40, multiply that total by
52, then divide by twelve.
If
you earn overtime, bonuses, or commissions  it isn't as easy.
Lenders don't give you credit for what you are currently earning.
They average your income from those sources over the last two years,
then add that to your regular salary or hourly monthly income. If
you want a shortcut that is usually close, get out your W2 forms
for the last two years. Add them together and divide by twentyfour.
That is your monthly income.
If
you are a teacher, a nurse, a seasonal employee, in construction,
or earn only parttime income  you can use that shortcut, too.
Add the figures from your last two years W2's, then divide by 24.
It generally gets you close.
If
you are selfemployed or receive 1099 income, then you need a twoyear
track record. Lenders go by what you declare to the IRS as income,
since that is documentable. Since some selfemployed people overstate
their expenses, this may understate your income. Look at the Schedule
C of your tax returns for the last two years and the number at the
bottom that says "profit" is your annual income. You can
add any depreciation to that figure. Add them together and divide
by twentyfour.
There
are variations and exceptions (like those who own their own corporations)
but the above should cover most people.
Step Two  Working Backward
Once
you have calculated your monthly income, multiply it by the back
ratio for your particular loan. For generic purposes, it is fairly
easy to work with thirtyeight. Take 38% of your monthly income
or multiply it by .38. That tells you the maximum the lender wants
you to spend on your housing costs and monthly consumer debt combined.
Now
get out your bills and total them up to determine what you spend
monthly on debt. Do not include your auto insurance or your utilities.
Just creditors. For credit cards, use the minimum required monthly
payment unless it is less than ten dollars. The rest should be fairly
straightforward.
Deduct
that amount from the total the lender wants you to spend on housing
costs and consumer debt combined. Now you know the maximum the lender
wants you to spend for housing costs, unless the figure is greater
than 33% of your monthly income (there are exceptions, of course).
Step
Three  a Little Guesswork
The
next step requires a little guesswork. If you have a vague idea
of what price you might qualify for, you can estimate what your
annual property taxes and homeowners insurance might cost. From
there, you can easily calculate the monthly equivalent. Subtract
those figures from your maximum monthly housing costs total.
If
you are buying a condominium (or an area with HOA fees), subtract
out an approximate figure to cover homeowners association fees.
What you are left with is your maximum principal and interest payment.
The
Final Step  Almost
Now
you have to go to a mortgage calculator (click here) and plug in
some numbers. In the "payment" area, put the figure you
just calculated. Plug in the current fixed interest rate. If you
are putting less than twenty percent down, add a half percent to
the rate to allow for charges you will pay for mortgage insurance.
Hit
the calculate button and you should have your maximum mortgage amount.
Add your down payment and you know your maximum purchase price.
Maybe.
You may have to do some finetuning to zero in on the exact figure.
Plus, lenders know how to "stretch" a client a bit higher
if they need it.
Advice
If
the figure is less than you expected (or need), lenders know programs
that will help "boost" you higher in qualifying. Plus,
they will do what you just did for free, they are much more experienced
at the various nuances involved, and you will have no obligation
to use them as your lender.
All
you have to do is pick up the yellow pages and a phone.
copyright
2000 by Terry Light and RealEstate
ABC

Art
Busch
ABR, GRI
3166867121
3169907039
email
me 
PLAZA REAL ESTATE, INC.
12221 E. Central
Wichita, KS 67206
