CHAPTER VII -- REALITY CHECK

LESSON 13: HOW MUCH HOUSE CAN YOU AFFORD?

Now you know the basic things lenders look at on a loan application. But before we go any further, we should talk more about how to determine how much house you can afford.

Experts say most borrowers spend about a third of their incomes on home loans.

As we touched upon in the last lesson, lenders don't want too much of their borrowers' paychecks going toward debt service. To figure out if a customer owes too much, a lender will compute two debt-to-income ratios:

The housing expense, or front-end, ratio: This shows how much of your gross (pretax) monthly income would go toward the mortgage payment if you were approved. Lenders consider the entire payment, including any real estate tax and homeowner's insurance charges, rather than just the principal and interest payment. As a general guideline, housing payments shouldn't take up more than 28 percent of a borrower's income.

Total debt-to-income, or back-end, ratio: This shows how much of your income would go toward all debt obligations, including the mortgage, car loans, child support and alimony, credit card bills, student loans and condominium association fees. Generally speaking, your total monthly debt payments should not take up more than 36 percent of your gross income.

 Let's take a home buyer who makes \$40,000 a year. The maximum amount of money available for a monthly mortgage payment, given a 28 percent of gross income cap, would be \$933. The maximum amount available for all debt payments, given a 36 percent cap, would be \$1,200. The following chart will help you see where you fit in:
 Gross income 28% of monthly 36% of monthly \$20,000 \$467 \$600 \$30,000 \$700 \$900 \$40,000 \$933 \$1,200 \$50,000 \$1,167 \$1,500 \$60,000 \$1,400 \$1,800 \$80,000 \$1,867 \$2,400 \$100,000 \$2,333 \$3,000 \$150,000 \$3,500 \$4,500

(continued on next page)