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Home Buying Preparation

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2013 Housing Market Remains Strong For Sellers

How Much Home Can You Afford?

Planning to buy a home this year? Although home prices are rising and mortgage rates have climbed out of their lifetime lows of 2012, the market remains ripe for buyers as compared to recent years.

Home buyer purchasing power remains near all-time highs and low and no downpayment mortgages are readily available, including the Conventional 97 program from Fannie Mae which allows for a 3% downpayment with or without a downpayment gift, and is available in all 50 states.

Start by checking your budget against today’s mortgage rates. Get today’s rates and see for how much home you’ll qualify.

Among the most common questions from a home buyer is “How much home can I afford?” The answer, however, like many things, is that “it depends.”

There are no concrete rules for how much home you can afford, or how big your mortgage should be. This is because the way that a mortgage lender calculates your maximum purchase price will be different from how you would calculate it yourself.

Let’s look at both approaches to home affordability.

Using DTI To Determine Maximum Purchase Price

When a mortgage lender calculates a home buyer’s maximum home purchase price, it doesn’t actually consider the purchase price of the home. Rather, it looks at the buyer’s expected mortgage loan size and the current mortgage rates to determine the expected monthly mortgage payment, and then compares that figure to the buyer’s monthly income.

This comparison is known as the Debt-to-Income Ratio. Sometimes called DTI, the ratio has two components.

Debt-to-Income : Front-End Ratio

The first component of the debt-to-income ratio is the “front-end ratio”. Front-end ratio compares the expected monthly housing payment to a buyer’s monthly income, where “housing payment” includes all of the following obligations:

• Monthly principal + interest payments
• Monthly real estate taxes due
• Monthly homeowners insurance due
• Monthly dues due to an association

There is no maximum limit for a front-end ratio, but lenders prefer to see front-end DTI of 28% or less. In other words, no more than 28% of a buyer’s monthly income should be allocated to housing payments.

Debt-to-Income : Back-End Ratio

The second component of debt-to-income ratio is the “back-end ratio.” Back-end ratio compares not just the monthly housing payments against a buyer’s monthly income, but all monthly payments.

Back-end ratio accounts for all of the following monthly obligations a home buyer may have:

• Monthly housing payment(s)
• Monthly minimum credit card payments
• Monthly child support or alimony
• Monthly car payments for a car loan or lease
• Monthly payments to an installment loan such as a timeshare

In general, banks want to see a back-end ratio of 36% or less, however, having a DTI over 36% will not automatically disqualify your mortgage application. Many lenders allow up to 45% debt-to-income.

Mortgage Lenders Use FICO Scoring Model

There are numerous credit reporting companies and you’ve likely seen their ads on TV or online. However, in the mortgage world, there are three companies which matter most — Equifax, Experian, and TransUnion. Collectively, these three firms are called the “major credit bureaus” and each sells a multitude of credit scoring products.
For mortgage purposes, each sells one credit score of consequence to mortgage applicants:

• Equifax : Equifax Beacon 5.0
• Experian : Experian/Fair Isaac Risk Model v2
• TransUnion : FICO Risk Score 04

When a mortgage lender “pulls your credit,” these are the three credit scores which are reviewed. Your lender will then take the middle of the three scores, and this will be your assigned credit score. For example, if your credit scores are 620, 640, and 700, your “score” is 640. As another example, if your credit scores are 700, 719, and 720, your credit score is 719. Credit scores are not rounded up or averaged.

Credit scores are called FICO scores, named after the Fair Isaac Co., a pioneer in the credit scoring space.

How To Boost Your Credit Scores

When you order a credit report, along with your credit scores, the credit bureaus often offer several ways by which you can improve your credit score.

For people whose credit scores are low, this can be a roadmap for FICO improvement. For people whose credit scores are very high, it may be extraneous information; you can’t get “bonus points” for having an extra-high FICO.

Take the credit bureaus’ recommendations under consideration, but remember that there are only a few fool-proof ways to improve your credit score.

1. Pay your bills on time, every time.
2. Keep your credit card balances low as compared to your total available credit.
3. Apply for store charge cards only when absolutely necessary.
4. Pay doctor and utility bills when they’re due.
5. Keep old credit cards open, and use them periodically.

Ideally, your credit card balances should not exceed 30 percent of the card’s available balance. If you are having trouble meeting this requirement for a high credit score, ask your credit card company to raise your credit limit. Lastly, if you’ve had a derogatory event on your credit report, “bad credit report.”

 

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