With recent changes to the mortgage loan industry and the increase foreclosure rate in many US markets, the availability of easy mortgage money may be limited. Either way, it is better to be smart about the debt you decide to risk your credit and finances over. Lenders will also make determinations on how much loan you can afford based on your income, as well as your current debts (e.g.: car loans, credit cards, etc.). Additionally, they will assess your ability to pay with how much of the “Two Cs”---cash and credit---you actually have (see “What You Need to buy a Home: The Two Cs” to see how these factors can assist or hinder your loan amount and interest rates).

How Much Loan Can you Afford?

Lenders determine how much they are willing to lend you based on two ratios: the Housing Expense Ratio and Debt-to-Income Ratio.

The Housing Expense Ratio suggests that your entire housing expenses monthly payment---including the principle, interest, taxes and insurance---should be no more than 25-31% of your total monthly expenses. Your Debt-to-Income Ratio suggest that your total debts should be no more than 30-41% of monthly income. Keep in mind that this includes all debts-- the monthly housing expenses described above, and creditor debts (like credit cards, car loans, student loan payments, etc.)

The ratio fluctuations are based on the types of loan products that are available. You may be able to make estimations of how much a lender will approve to lend based on the Housing Expense and Debt-to-Income ratio, but you will not truly know how much home you can buy until you go through prequalification and/or preapproval.

Prequalification v. Preapproval

Prequalification is an assurance of how much a lender may be willing to lend you based on your income, credit score, debt ratio calculations, and available loan programs. It is not a guarantee for a loan, but it will give you a clearer idea of your price range when selecting a home. You can also show the prequalification letter to a seller to demonstrate that you can afford the home they are offering.

Preapproval is a guarantee from a lender for the loan amount htat you qualify for. Essentially, you would be going through the comprehensive home loan application process before selecting a home. Should you get approved, the lender will provide a preapproval letter stating that they will honor the loan for a limited time period (generally 45-60 days), thereby giving you time to find a home for purchase. A preapproval letter is an even stronger negotiating point with a seller, as he or she is aware that you have the financial backing to buy immediately.

Once you have documentation of your preapproval, it is now time to select a home that has the characteristics you desire, but is still within your price range. Please see “The Two Sides of Homeownership: The Property” for ways to pinpoint what you need, with or without a realtor.

References

Neighbor Works America. Realizing The American Dream
Credit Union National Association. News Now