From How Much You Make to A Payment and Price You Can Afford

I'm clueless about how home loans work. Is there any way to figure out how much I can afford to spend per month on a home. If I were to get a home for $(figure) how much would that be per month? How do I know how much the interest will be? Any sites that explain it all in laymans terms? Thanks

It's actually pretty easy. You are allowed a certain percentage of your gross monthly salary for debt service and housing. According to Fannie Mae and Freddie Mac, who control A paper, it's essentially 45%. When I originally wrote this, some sub-prime lenders would go to 60 percent, but 1) that is essentially gone and 2) Don't you think it's a good idea to stay within the limits considered acceptable by the people with the best rates and most favorable terms? This ratio is called the debt to income ratio and is far and away the most important measure of qualification.

Lest it not be obvious to you, the less debt you have currently, the more you can afford to take on for a housing payment. One of the real problems, and reasons for abuse of a stated income loan, is couples who make $4000 per month each, but have $1200 or $1500 or $2100 in monthly payments for the two cars, credit cards, student loans, etcetera. Their coworkers all have $3000 mortgage payments, and $3000 buys a lot more house than the $1800 which is all they can afford. Actually, it's a pretty critical difference right now, since $1800 is the payment on about $275,000, while $3000 is the payment for about $450,000 or a little more. The reason why people pay more for property is always that the higher priced property is desirable enough to be worth the difference to them.

Take 45 percent of your gross monthly income, call it X. From X, subtract your current debt service. This is car payments, credit card payments, furniture payments, student loans, and any other actual debt you have. It does not include things like utility bills, however.

The number that is left over, call it Y, is what you can afford for housing by traditional measures. It needs to cover principal and interest of the loan, property taxes, home owner's insurance, and association dues (if any), PUD fees (if any), and Mello-Roos (if any).

Assuming that there are none of the last three, you're left with PITI, the acronym you're going to hear about what this covers: Principal and Interest (on the loan), Taxes (property taxes) and Insurance (home owner's insurance).

When I originally wrote this, there were A paper thirty year fixed rate loans in the low sixes with 1 total point or less. Rates are lower right now, but they vary over time. Any loan calculator (except auto loans) can handle that calculation.

There are complicating factors if you're not putting 20% down. If you're not putting twenty percent down payment, every lender out there will require Private mortgage insurance (PMI) in some form or another. Banking regulations require it. If it's something the loan market will support in your situation, splitting your loan into a first and a second is almost certainly superior to paying PMI. At this update, second mortgage lenders are requiring a minimum 10% down payment or 15% equity on a refinance. To do this, you're only going to put 80% of your loan on the first mortgage. Adding the remaining amount back in at 9.00% (doing this saves you about two and a quarter percent in charges on the whole amount), for which you're going to need to do a separate calculation. If you are in a situation where you're splitting your loans, put the two payments together and that's the principal and interest (PI) part of the PITI acronym. This assumes you've got decent credit, by the way.

I have no way of knowing your property taxes. Every state in the union has their own way of doing it. California's is actually one of the lower property tax rates, considered on an assessment per unit of value basis. There are also zones where bond issues have passed, Mello Roos assessment districts to pay for the costs of bringing utilities to the development, and so on and so forth. Your county assessor will have the details. One of the things a good agent can often do here in California is deduce the presence of assessment districts based upon the taxes paid by a particular property, but it's subject to error, and your county assessor's office will have the information, and it won't b subject to guesswork.

I have no real way of knowing what home owner's insurance might be. I usually estimate $100 to $110 per month for a good policy covering detached housing, but that's a guess, and it could be much more, or somewhat less, depending upon many factors. Most of the actual quotes and bills my clients get seem to be lower, but better to guess a little high when making a budget for a major purchase like that. The only way of moving from guess to certainty is to ask insurance agents how much to insure a specific property with a given level of coverage. Don't shop insurance based solely upon price - be careful about the level of coverage - I strongly urge the HO-3 standard policy for stand alone residences, and the HO-6 for condominiums and townhomes where the association has a master policy. The HO-15 Rider is also worth considering as a policy addition. These are actually nationally standardized policies, thanks to the NAIC. Lenders have requirements for what policies have to cover depending upon state, as well. Also consider level of coverage - a policy that isn't big enough won't pay the entire bill for repairs even if it is within coverage maximum. Finally, how solid is the company? Seems like every time there's an area disaster, you hear about insurance companies going bankrupt because they can't pay claims. This is not something you want happening to you. Make certain they've got a high rating from major rating services.

I should also mention that no basic policy includes flood or earthquake insurance. If you're in an earthquake area like most of California, get yourself an earthquake rider or separate policy, whatever is needed in your state. Flood insurance isn't something you worry about around here, but buy it if you're on a flood map.

Now, if the sum of these numbers (PITI) is less than $Y, that portion of your monthly income available for payments and left over after monthly debt service, you've got an excellent chance of qualifying for that loan. If not, you're going to have to go sub-prime, where the allowed debt to income ratio is higher, but the rates will also be higher and the terms less generous, for instance in the presence of a pre-payment penalty. It is actually likely that instead of playing games to stretch your ability to qualify, you would be better off shopping for a less expensive property in the first place. But that's a hard thing to get most buyers to accept. They've fallen in love with the brand new house and they don't want to hear that they can't really afford it. The universe knows that these good deeds do not go unpunished. But informing the client is still the right thing to do, as is deciding to find another property, one that you really can afford.

Caveat Emptor

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