Trending: Pre-Approval Letters. How Much Can I Get to Buy a Home?
Happy New Year! Is buying a new home on your 2021 to-do list? Are you curious how much you could qualify for to buy a home?
In this series, we break down trending terms or concepts that need a little more explanation.
Today: Pre-Approval Letters
- The home buying qualification process underwrites loan-to-value (LTV) ratios, debt-to-income (DTI) ratios, and credit scores.
- LTVs should be 80% or below, DTIs should be 45% or below, and credit score should be 700 or above. (Should is not a must. Exceptions can be made.)
- Skip to the end if you just want to read my “example”.
- Email me at Huber@StackSource.com for my personal excel spreadsheet that makes it easy to determine an approximate home qualification amount that’s specific to you.
“Home Prices Are Rising Everywhere in the U.S.”- WSJ
So you want to buy a home, but you don’t know where to start.
Do you call a sales agent to start showing you properties? Do you call a loan originator to determine how much you can afford? There are so many questions to ask and this is a BIG decision.
I know that the home buying process can be daunting, so hopefully I can help make your life easier with a little more peace of mind.
Home Qualification Overview
The home buying qualification process underwrites loan-to-value (LTV) ratios, debt-to-income (DTI) ratios, and credit scores. Each of these topics is a blog in its own right. I’ll focus on the DTI metric since this is the main tool used to determine your purchasing power.
Debt-to-Income (DTI) Ratio
Your DTI ratio is a formula that compares how much you owe each month to how much you earn each month. In the picture below, the numerator is “monthly debt payments” and the denominator is “gross monthly income” (before taxes).
Let’s first break down Gross Monthly Income.
Gross Monthly Income
For those that make a W2 income and have no other sources of income that need to be qualified, the breakdown is pretty simple. Look at your paycheck. Do you get paid monthly, semi-monthly, or bi-weekly? Next, determine your monthly income.
- If paid monthly, your gross paycheck income is what we use to qualify.
- If paid semi-monthly, multiply your gross paycheck income by 2 to get your monthly total.
- If paid bi-weekly, multiply your gross paycheck income by 26 and then divide by 12 (If paid bi-weekly, you get 26 paychecks in one year and then divide by the 12 months in a year to get your monthly qualifying income).
If you get paid bonuses, take the average annual bonus total over the past 2 years and divide by 24 months to get your monthly average.
Add your gross monthly income and your average gross monthly bonus together to get what we use for the denominator for your DTI formula.
Let’s next break down Monthly Debt Payments.
Monthly Debt Payment
“Monthly Debt Payments” are all the minimum monthly payments for anything you’re responsible for AND the mortgage payment for the property you are about to buy. Items that you’re responsible for include, but are not limited to,:
- Credit card debts
- Mortgage loans
- Student loans
- Car loans
- Child Support
Monthly Debt Payments are the minimum monthly obligations totaled above plus the monthly Principal, Interest, Taxes, and Insurance (PITI) for the new home loan that you are applying for.
Bankrate.com does a great job of breaking down PITI and even provides a calculator to help you approximate. The snapshot of my spreadsheet below assumes:
- 3.00% mortgage interest rate
- 30 year fixed term
- $75 per month homeowners insurance
- The property is in California which assess annual property taxes by multiplying 1.25% of the purchase price.
Let’s now put it all together.
For this example, let’s call my client “Lucy”.
Lucy is a W2 employee and receives a paycheck twice a month (semi-monthly). On each paycheck, her gross income says $4,500. She also tells me that she gets a bonus every year. In 2019 she got $10,000 and in 2020 she is expected to get $15,000 by year’s end. Looking at the income box above, I would be able to approve her for $10,042 in qualifying monthly income.
The max DTI ratio permissible without additional conditions is 45%. 45% of Lucy’s qualifying monthly income is $4,519. This means that, each month, Lucy can spend $4,519 in both total minimum monthly debt obligations and the new mortgage (PITI) for the home she wants to buy.
Lucy estimates that the total minimum monthly debt obligations for her credit cards, student loans, auto loans, etc. is $850 per month. That means Lucy now has $3,669 to spend on a potential new mortgage ($4,519 minus $850).
Using the appropriate formulas in my excel spreadsheet (which if you email me at Huber@StackSource.com I will gladly share with you), I determined that the max loan amount she would qualify for is $683,520. Lucy expressed that she has 20% for a down payment ($170,880).
In this example, I would be able to provide Lucy with a pre-approval for $854,401 and she would next hire a realtor, show them my pre-approval letter, and start giving offers on homes less than her $854,401 maximum.
This spreadsheet provides a rough approximation of your purchasing power and is not an actual pre-approval letter. You will need to contact a licensed mortgage loan originator so that they can better understand your full financial picture. Investment properties, self-employment, independent contractors, etc. are all factors that would affect your purchasing power and are not captured in this spreadsheet.
I completely understand the hesitation in picking up the phone out of fear of getting a “salesy salesman” on the other line; moreover, the fear of giving up personal information like your social security number.
Hopefully this explanation paired with my spreadsheet will help you research with confidence as you continue down your journey towards home ownership. Happy house hunting!
Good luck out there my friends.
I’m happy to engage with you in the comments so that everyone can learn. If you prefer to share privately, feel free to email me at email@example.com
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