When it comes to finding the right size home, there are a lot of people wanting to weigh in. Your realtor works on commission, so the bigger the better! Your lender also in general makes more money on bigger sales. Then there’s your parents who want you to have 5 bedrooms for all the grandchildren you’re going to give them. The realtor and your parents one can understand. But when it comes to the lender, many first time homebuyers tend to think the lender’s math is mysterious and somehow knows your budget and what you can afford. Let’s demystify that part of the process so that you can find the house that’s not too big or too small, but a house in your budget.
The lender looks at 3 primary factors when they decide whether to extend you a mortgage loan, and for how much.
3 Primary Factors
- Credit Score. The minimum required is determined by the type of loan and the specific lender’s guidelines, but generally it’s in the 620-640 range. This is what gets your foot in the door.
- Income. Your income primarily determines how MUCH loan you can take out. FHA loans (a common choice for first-time homebuyers) say that you can afford paying up to 31% of your gross earnings on a mortgage. So for example, if you pay taxes on $40,000 they’d say your maximum mortgage payment can be $1033 a month.
- Other debts. The lender will review over the credit report to see how much you’re promised to pay monthly on other debts. For the FHA loans mentioned above, they don’t want your total debt payments to be more than 43% of your gross earnings. So in our example above, if the person with $40,000 income also had student loan payments of $200/month, a car payment of $300/month, and credit cards of $100/month, that’s already using up 18% of the income. That leaves $833/month for a house payment instead of the $1033/month for the person with no other debts. That means a smaller mortgage and a smaller home.
Two Big “Takeaways” From the Above
- Amount of debt matters. Having a small credit card or a car loan is fine for building your credit in anticipation of buying a home. But quality is more crucial than quantity. If you have large outstanding balances, it could be detrimental to getting a house that’s big enough to meet your needs.
- Net income. Nowhere in the discussion above does the lender look at your actual take-home pay. They don’t know if you are paying child support out of that check, trying desperately to contribute to your 401k, pay exorbitant medical insurance or prescriptions costs, or if you are sending your daughter in college a couple hundred dollars a month to live. Those are all factors that you personally have to account for. So if you’ll humor me in math’ing the example above, $40,000 a year is about $3333 gross pay per month which would work itself out to about $2333 take home pay after standard deductions. Having a $1033 monthly mortgage payment means you’re leaving yourself $1300 or a little more than half your net pay to cover utilities, food, gasoline, internet (don’t forget Netflix), hair cuts, staff lunch out on Fridays, Christmas and birthday presents, and of course upkeep on the car and new house. In other words, spending plans are good and getting a house in your budget is key.
If you need help at any step along the way, Apprisen is here to come alongside you. Confused about escrow? Wondering the difference between FHA, DTI, and all the acronyms? Trying to understand the quote the lender gave you? We have answers! We offer free HUD-Approved Housing Counseling for first-time homeowners. If you need another resource to help you buy a house in your budget, check out our Financial Health Plan. The comprehensive session can help you set credit-building goals , create a budget, get a home down payment savings projection plan so you’ll stay on track with your savings goal.