Purchase A Cheaper Home
If you have low interest student loans which will take many years to extinguish it may make sense to start your housing journey with a cheaper home that is a bit smaller or a bit further from work in order to get started on the housing ladder.
Some people view renting as throwing money away, but even if you put 20% down on a home you are 5X leveraged into a single illiquid investment. Getting laid off during a recession can lead to forclosure.
Over the long run other financial assets typically dramatically outperform real estate. Buying a home for most people is more about investing in emotional stability instead of seeking financial returns.
Real Estate Price Appreciation
Real estate can see sharp moves in short periods of time, though generally tends to keep up with broader rates of inflation across the economy over long periods of time. In 2006 near the peak of the American housing bubble the New York Times published an article titled This Very, Very Old House about a house on the outskirts of Amsterdam which was built in 1625. They traced changes in property values in the subsequent nearly 400 years to determine it roughly tracked inflation.
Longterm Stock Market Returns
How Much Of Your Income Should Go To Your Mortgage
Whether its a real estate investment or the purchase of a forever home, buying property is almost always an expensive endeavor. A home purchase is easily one of the largest investments consumers will make in their lifetime, so understanding all the costs involved is crucial.
But when youre buying a home, its important to not only consider the overall cost, but also the monthly costs, as these will help you to build your budget and determine how much home you can really afford. So, if youre not sure how to determine the right percentage of income for a mortgage, this article is for you!
Rules May Vary By Lender And Loan Program
In very exceptional circumstances, lenders may bend some income rules for favored borrowers. For example, suppose youve been with a local institution for decades. If it knows you have an unblemished payment record and a stellar credit score, it may be willing to bend policy a little.
Equally, Fannie and Freddie write their rules for particular mortgage products. For example, Fannie usually excludes rental income from a mortgage application. But it makes an exception for its HomeReady mortgage. If you apply for one of those, Fannie can count all the income you receive from boarders and renters, provided theyve lived with you for at least a year prior to buying the home.
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How To Increase Your Mortgage Affordability
If you want to increase how much you can borrow, thus increasing how much you can afford to spend on a home, there are few steps you can take.
1. Save a larger down payment: The larger your down payment, the less interest youâll be charged over the life of your loan. A larger down payment also saves you money on the cost of mortgage default insurance.
2. Get a better mortgage rate: Shop around for the best mortgage rate you can find, and consider using a mortgage broker to negotiate on your behalf. A lower mortgage rate will result in lower monthly payments, increasing how much you can afford. It will also save you thousands of dollars over the life of your mortgage.
3. Increase your amortization period: The longer you take to pay off your loan, the lower your monthly payments will be, making your mortgage more affordable. However, this will result in you paying more interest over time.
These are just a few ways you can increase the amount you can afford to spend on a home, by increasing your mortgage affordability. However, the best advice will be personal to you. Find a licensed mortgage broker near you to have a free, no-obligation conversation thatâs tailored to your needs and free of charge.
Proof Of Income For A Mortgage Loan
When you apply for your mortgage, your lender will require several documents to prove that your income is as youve stated. For W-2 employees working in a traditional employment situation, this step is fairly simple. Youll have to provide your latest pay stubs, as well as two years of tax returns and W-2 forms.
Though you must provide two years of tax returns, lenders dont actually require that you be at the same job for two full years. Instead, theyll require two years of consistent income, preferably within the same field.
Things become a bit more complicated if you work in a job where your income is reliant on bonuses or commissions. According to Cohn, youll generally need at least two years of bonus or commission income for a lender to consider it, though it could be as little as one year if its offset by other factors.
If your variable income from the most recent year was higher than the previous year, theyd take an average of the two numbers. If the most recent years income was lower, theyd only use the lower number.
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Why The 28/36 Rule Of Thumb Generally Works
The 28/36 rule of thumb provides a pretty good guide for lenders to determine how much home you can afford.
As a mortgage lender, one of our jobs is to assess risk and the 28/36 rule is a big part of that, Edelstein said. You can be approved for a mortgage with ratios higher than 28/36, as high as 50% on the back-end. However, risk goes up and in order to be approved with higher ratios, you will have to have a strong credit score and possibly a larger down payment.
So, what is included in the DTI ratios calculation of your monthly debt obligations? Any of the following payments could be factored into your DTI:
- Future mortgage payment
- Alimony and child support payments
- Loans you co-signed for
Your DTI doesnt include utilities, cable, cellphone, and insurance bills.
What Else Is Included In Dti
Your debt-to-income ratio also considers auto loans, minimum credit card payments, installment loans, student loans, alimony, child support, and any other expenses you must make each month. It doesn’t typically include recurring monthly charges for utilities, internet service, cable or satellite TV, mobile phone subscription or other charges for ongoing services or other things where the cost is newly incurred each month.
To calculate if you have the required income for a mortgage, the lender takes your projected monthly mortgage payment, adds your expenses for credit cards and any other loans, plus legal obligations like child support or alimony, and compares it to your monthly income. If your debt payments are less than 36 percent of your pre-tax income, you’re typically in good shape.
What if your income varies from month to month? In that case, your lender will likely use your average monthly income over the past two years. But if you earned significantly more in one year than the other, the lender may opt for the year’s average with lower earnings.
Note: Your required income doesn’t just depend on the size of the loan and the debts you have but will vary depending on your mortgage rate and the length of your loan. Those affect your monthly mortgage payment, so the mortgage income calculator allows you to take those into account as well.
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Common Eligibility Income Criteria Required For A Mortgage
In the mortgage world, there are two ratios to keep in mind when considering how much home you can afford:
- Front-end debt to income ratio: the percentage of your gross monthly income thats spent on your mortgage payment
- Back-end debt to income ratio: the percentage of your gross monthly income thats spent on all debt obligations
*Quick note: If youre self-employed, the lender will use your net income . To reach the monthly income figure, they will divide the total youve earned, as reflected in your two most recent tax returns, by 24. To illustrate, if the sum of your net income is $144,000 for the past 24 months, the lender will use $6,000 as your monthly income figure.
Historically, the rule of thumb was that your front and back-end DTI ratios shouldnt be more than 28 percent and 36 percent, respectively.
But nowadays, theres generally a lot of flexibility with those figures. In fact, several lenders permit DTI ratios of up to 43 percent, and some go even higher. It depends on your credit score, assets and down payment amount.
How To Improve Your Dti
We’d like to tell you to just spend less and save more, but you’ve probably heard that before. It might be different, though, if you could see your progress in tangible terms, and your DTI can do just that. If you calculate the ratio yearly , you will hopefully see the percentage drop steadily. If you conscientiously work your total debt downward, your DTI ratio will reflect that, both to you and to potential lenders.
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What Is A Stable Income And How Does It Affect Your Mortgage
A stable income: understanding your mortgage income requirements
So, youre thinking about buying a property and you want to take out a mortgage. When you apply for a mortgage, youll need to prove that you can afford the monthly mortgage payments and that you intend to pay the money back.
Youll need to meet the income requirements for the loan and part of that may include showing that your income is stable and regular.
Its a good idea to check out how much you can afford to borrow using a mortgage calculator before you speak to lenders, but remember, its only a guide and not a firm mortgage offer.
Other Requirements To Qualify For A Mortgage
The amount of money you earn isnt the only thing that matters when buying a home. You should be mindful of other factors lenders take into consideration when reviewing your application:
- : Most mortgage programs have a minimum credit score requirement. Conventional loans require a 620 FICO score FHA loans require a 580 minimum VA loans usually require 580-620 USDA loans require a 640 score
- : Your recent credit history also determines whether you qualify for a home loan. Most programs dont allow more than one 30-day late payment within the previous 12 months. You can also expect a waiting period after a foreclosure or bankruptcy, which can range from two to seven years depending on the home loan
- Down payment: The size of your down payment also affects your qualifying amount. Borrowers with a bigger down payment have greater purchasing power
- Existing debt load: Too many existing debts also reduces purchasing power. Paying down a car loan, a student loan, and credit cards can increase affordability.
- Assets/cash reserves: You need enough cash saved to cover the down payment and closing costs. Lenders may want to see cash reserves, too, meaning you have enough cash left over in the bank to cover 2-6 months worth of mortgage payments if your income were to be cut off
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Loans Which Dont Use Dti For Approval
Mortgage lenders use DTI to see whether homes are affordable for a U.S. home buyer. They verify income and debts as part of the process.
However, there are several high-profile mortgage programs which are more flexible about the DTI calculation. These include loan options from the FHA, the VA, and Fannie Mae and Freddie Mac.
Most Affordable Markets For Homebuyers
According to 2020 data fromZillow Research, record low mortgage rates have helped to boost affordability for potential homeowners. The table below shows the top 10 most affordable markets to live in for December 2020 and is based on a typical home value of no more than $300,000 . The market and share of income spent on a mortgage may fluctuate based on the current mortgage rate, the typical local homeowner’s income and the typical local home value.
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Percentage Of Income Rules And Guidelines
Although most personal finance experts recommend the 28% rule, there are several other rules and guidelines that can be helpful in your calculations. With the following percentage of income rules, you can feel confident in determining precisely how much to put toward your monthly payments, so lets get into it.
Determine Your Required Income With A Mortgage Calculator
This home affordability calculator is a useful tool that helps you determine the income required for a mortgage and the overall cost of homeownership at todays mortgage rates. This includes your loan principal, interest rate, property taxes, and homeowners insurance commonly referred to as PITI.
PITI is an acronym that means:
- Principal: The amount of your mortgage loans principal balance repaid each month
- Interest: The amount of interest your mortgage lender collects on the loan
- Taxes: Property taxes required by your city and county government
- Insurance: Homeowners insurance and, if required, private mortgage insurance premiums
The mortgage calculator will estimate your monthly payment using your PITI and additional inputs, including purchase price, down payment, state of residence, and loan term. Furthermore, youll be able to filter results by monthly mortgage payments, income requirements, and home price.
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Can You Receive Money For A Down Payment From A Friend Or Relative
Lenders generally allow homebuyers to receive gift money from loved ones for their down payment. Under Fannie Mae and Freddie Macs requirements, these gifts can only come from a family member related by blood, marriage, adoption, or legal guardianship. The gift may also come from a fiancé or domestic partner.
If you receive your down payment money as a gift, youll also have to provide a gift letter written by the donor. The gift letter should specify the dollar amount of the gift, the date, and confirmation that the gift isnt a loan and no repayment is expected.
Income Rules And Rule Makers
Mortgage lenders all have the same legal obligation to ensure your ability to repay. But some interpret that duty differently. So if youre turned down by one lender, it may be worth trying others.
If you want a government-backed home loan, the rules on income for mortgage qualification are written pretty tightly. Those government-backed mortgages include Federal Housing Administration loans, Department of Veterans Affairs loans, and U.S. Department of Agriculture loans.
Fannie Mae and Freddie Mac also closely specify the income streams theyre prepared to accept for conventional loans. However, those arent chiseled in stone. Conventional mortgages may be more flexible when it comes to income qualifying than government-backed mortgages.
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How To Use The Mortgage Affordability Calculator
To use our mortgage affordability calculator, simply enter your and your partnerâs income , as well as your living costs and debt payments. The calculator can estimate your living expenses if you donât know them.
With these numbers, youâll be able to calculate how much you can afford to borrow. You can also change your amortization period and mortgage rate to see how that would affect your mortgage affordability and your monthly payments.
When Is Predicted Rental Income Accepted For Underwriting
Sometimes, rental income cant be proven via a tax return. Say, for example, youve just purchased the property, or you purchased the property in the middle of the year and only show a portion of the rental income on your tax return.
In that case, the rental income would be considered predicted and may be used under certain circumstances for underwriting purposes. Again, its a matter of being able to show proof of the propertys income potential.
If the renter has a tenant, lenders will take a percentage of the income thats outlined on a lease and use that to determine projected rental income. They usually use 75% of your total reported income 25% is subtracted to account for potential vacancies and ongoing maintenance.
If theres no tenant, the lender will have an appraiser do an audit of the property and use comparables of rental prices for similar properties in the area to estimate the potential rental income.
When is predicted rental income not acceptable?
Predicted rental income is not always acceptable for underwriting, though. First and foremost, you may have a problem getting it counted if it cannot be documented . This is because lenders sometimes request copies of checks as proof that the rent is regularly being paid on time.
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How To Estimate Affordability
There is a rule of thumb about how much you can afford, based on the calculations your mortgage provider will make. The rule of thumb is that you can afford a mortgage where your monthly housing costs are no more than 32% of your gross household income, and where your total debt load is no more than 40% of your gross household income. This rule is based on your debt service ratios.
Lenders look at two ratios when determining the mortgage amount you qualify for, which generally indicate how much you can afford. These ratios are called the Gross Debt Service ratio and Total Debt Service ratio. They take into account your income, monthly housing costs and overall debt load.
The first affordability guideline, as set out by the Canada Mortgage and Housing Corporation , is that your monthly housing costs â mortgage principal and interest, taxes and heating expenses – should not exceed 32% of your gross household monthly income. For condominiums, P.I.T.H. also includes half of your monthly condominium fees. The sum of these housing costs as a percentage of your gross monthly income is your GDS ratio.
