If you are considering the purchase of a home, it is very important to determine the price range you can afford prior to your search. By establishing price boundaries and becoming familiar with how lenders qualify borrowers, you can be better prepared to streamline your search for an affordable home.
Lenders typically consider a variety of factors when qualifying a borrower for a home loan. Among the primary considerations are the following two ratios based on the borrower's gross (pre-tax) monthly income:
* Housing expense ratio. The housing expense ratio is typically 28 percent and is used by lenders to determine if a borrower's gross monthly income can adequately pay for anticipated housing-related expenses-such as principal, interest, property taxes, homeowner's and hazard insurance, association dues, etc. If needed, private mortgage insurance (PMI)--insurance required by lenders, when a down payment does not equal 20 percent of the purchase price--is also considered a monthly housing-related expense. Generally, as part of the loan qualification criteria, a borrower's housing-related expenses should not exceed 28 percent of his or her gross monthly income (or gross household income if two family members will be applying for the mortgage loan).
* Total debt ratio. The second ratio considered, the total debt ratio, is typically 36 percent, and is used by lenders to determine if a borrower's gross monthly income can adequately pay for housing-related expenses plus any other fixed monthly debts-such as student loans, child support, health insurance, credit cards, utilities, etc. Generally, to qualify for a loan, a borrower's total debt ratio should not exceed 36 percent of his or her gross monthly income.
Keep in mind that some lenders may have slightly higher or lower ratio thresholds than the 28 percent and 36 percent ratios. Additional factors lenders consider include:
* Employment history. Job history and stability are key factors lenders consider when qualifying a borrower for a home loan. Preferably, lenders would like borrowers to provide documentation (tax records) showing two years of consistent income. If a borrower has recently started a new job, lenders may review recent paycheck stubs, consider the borrower's length of work with a previous employer and consider the industry in which the borrower is currently employed to determine loan qualification.
* Down payment. If a borrower can provide a 20 percent down payment, he or she will not be required to pay PMI. The money that would have gone toward the monthly PMI payment may instead be applied to the monthly principal and interest payments. If the borrower's down payment exceeds 20 percent, the loan amount may be reduced and consequently, so may the monthly mortgage payment. Keep in mind that there are a variety of programs available to help borrowers with down payments. These may range from the acceptance of a gift letter confirming the source of "gift money" for a down payment, to government-sponsored programs such as the Federal Housing Administration (FHA) loan program, which currently offers a lower down payment to qualifying borrowers.
Since lenders typically consider each of the above factors to obtain a comprehensive financial picture for each borrower, it may be wise to determine the price range you can comfortably afford to be a step ahead when the loan approval process commences.
The foregoing article is intended to provide general information about home buying and is not considered financial or tax advice from Union Bank. Please consult your financial or tax advisor.
Lawrence Henry is a senior vice president and regional manager for Union Bank, N.A., a full-service commercial bank providing an array of financial services to individuals, small businesses, middle-market companies, and major corporations.