What You Can Afford

What can I afford?

Roughly, you can afford to buy a house that costs three times your annual income. Real estate experts strongly recommend people get prequalified by a lender as a way of calculating exactly how much of a home they can afford.

When qualifying people for a loan, lenders look at a borrower's full financial standing. Lenders use the relationship between the borrower's projected PITI, or principal, interest, taxes and insurance payments, and their gross monthly income. Generally, lenders like to see the PITI not exceed 30 to 33 percent of the borrower's gross monthly income. They also consider the borrower's monthly debt payments, including the PITI, to income.

Some lenders have flexibility in these qualifying ratios.

What can a home buyer afford?

Even before starting to look at houses, find out what price house or condominium you can afford, says syndicated real estate columnist Dian Hymer. Roughly speaking, Hymer says, you can afford to buy a home equal in price to three times your gross annual income. More precisely, the price you can afford to pay for a home will depend on six factors:

1. your income;
2. the amount of cash you have available for the down payment, closing costs and cash reserves required by the lender;
3. your outstanding debts;
4. your credit history;
5. the type of mortgage you select; and
6. current interest rates.

Lenders also analyze your income in relation to your projected cost of home ownership and outstanding debts to determine the size loan you can have. Hymer says your housing expense-to-income ratio is determined by calculating your projected monthly housing expense, which consists of the principal and interest payment on your new home loan, property taxes and hazard insurance. The sum of these costs is referred to as "PITI."

Monthly homeowner association dues, if you're purchasing a condominium or townhouse, and private mortgage insurance are added to the PITI. Your housing expense-to-income ratio should fall in the 28 to 33 percent range, although some lenders will go higher under certain circumstances. Your total debt-to-income ratio should be in the 34 to 38 percent range.

What is the standard debt to income ratio?

A standard ratio used by lenders limits the mortgage payment to 28 percent of the borrower's gross income and the mortgage payment, combined with all other debts, to 36 percent of the total.

Jim Frannea, executive director of Consumer Credit Counseling Services, says the centers advise clients in this situation to produce records of rent being paid on time, utility bills and other monthly expenses to prove to the lender that you can meet a mortgage obligation. Meanwhile, lenders who did not hesitate to reject certain applicants in the past say they are becoming more flexible in accepting alternative forms of documentation and implementing new underwriting standards. The fact that some loan applicants are accustomed to spending 40 percent of their monthly income on rent -- and still promptly make the payment each time -- has prompted some lenders to broaden their acceptable mortgage payment amount when considered as a percentage of the applicant's income.

Other real estate experts tell borrowers facing rejection to compensate for negative factors by saving up a larger down payment. Mortgage loans requiring little or no outside documentation often can be obtained with down payments of 25 percent or more of the purchase price.

How long do bankruptcies and foreclosures stay on a credit report?

Bankruptcies and foreclosures can remain on a credit report for 7 to 10 years. "There are lenders, however, who will consider an applicant who went through a bankruptcy as recently as two years ago, as long as good credit has been reestablished," says Dian Hymer, author of "Buying and Selling a Home, A Complete Guide," Chronicle Books, San Francisco;1994.

Depending on when the bankruptcy was discharged and what kind of credit a borrower has reestablished since then, it needn't be an obstacle to obtaining loan approval. The longer ago the discharge occurred, the better off a loan applicant will be.

Also, depending on the circumstances surrounding the bankruptcy, lenders will lean one way or the other. For example, if a borrower went through a bankruptcy because his or her company had financial difficulties owing to, say, defense industry cutbacks, that says one thing to a lender.

If, however, a borrower went through bankruptcy because he or she over extended personal credit lines and lived beyond his or her means, that says quite another thing.