How Much House Can and Should I Buy?
Several factors must be considered when purchasing a home such as how much is a lender will lend, what factors affect buying power and why do lenders care about debt-to-income (DTI) ratios and loan-to-value (LTV) ratios?
- Gross Monthly Income -> $5,000
- Maximum mortgage, tax, insurance: $1,400 ($5,000 * 28%)
- Total maximum monthly debt including mortage, tax and insurance: $1,800 ($5,000 * 36%)
- Jane should buy a home in which her monthly debts (including mortgage) do not exceed $1,800/month.
Maximum Loan Amount / Debt to Income (DTI)
Lenders use a debt-to-income ratio (DTI) to determine how much they are willing to lend to a home buyer. DTI is the percentage of a buyer's monthly debts (as shown on your credit report) to gross monthly income (income before taxes). The monthly mortgage (principal and interest), property tax and insurance (PITI) should not exceed 28% of gross monthly income. The total monthly debt payment (mortgage, property tax, insurance, credit card, car loan, student loan, etc) should not exceed 36% of gross monthly income.
Before applying for a loan, consider paying off any credit card debts, especially if you are not receiving a low interest benefit (i.e. 0% or 3.99% for 12 months) because your monthly debt will be higher which will lower your buying power. Although some lenders will allow a DTI of up to 50%, it is highly recommended that buyers do not go beyond 36% DTI as this can be financially risky. See the example below of a buyer with an annual income of $60,000.
Example: Ms. Jane Smith, the home buyer
Loan to Value (LTV)
Lenders will always have a property appraised to ensure proper LTV ratio because they will not lend money for an overpriced home as it becomes a greater risk for them. Just because a buyer is putting down $10,000 and seeking a $90,000 mortgage for the purchase of a $100,000 home does not necessarily mean a 90% LTV (Loan Amount / Total Purchase Price). If the home is appraised at $80,000, the lender may view the requested loan amount at more than 100% and will not provide a mortgage for that specific home ($90,000 / $80,000 = 112% LTV)
