What’s the real method lenders use to figure out what you can afford? There are all these rules of thumb on the internet, but can you figure out the amount down to the penny? How will your debts play into it? What about your job type and how you get paid? Do these play a factor? Spoiler alert, yes they do. Does your credit score change things? Let’s hear the exact method us home lenders use right now.
There’s two main steps to the process. One, first we need to figure out what loan box you fit into best. Because they have slightly different rules. Now, number two is we’re going to do some quick math to figure out your max payment for the program you fit best. Once we have your max payment, we can easily back into the home size for that program. And done. It’s really that simple. So number one.
Now that we know your bucket, let’s get to your max payment. Now, disclaimer, there could be a difference between what you should spend and what you can spend. This video is going to cover the latter. We will figure out, to the penny, what the bank says you can qualify for, using the exact same method the bank uses. I trust that you’re responsible enough to decide what makes the most sense for you and your unique family scenario.
Okay, to do this, we need to know just two more pieces of information. How much do you make per month before taxes exactly? And what are your minimum monthly debts? Those include credit cards, student loans, and car payments. We’re looking for minimum payments here. This will tell us exactly what payment you can afford. We compare your monthly debts to your monthly income.
You might have heard of this before. In the loan world, we call this your debt to income ratio, or DTI for short. This is what decides your maximum house payment. It’s different for each loan type.
Here’s A Quick Example
If you make five thousand dollars before tax, and have no car payment, credit cards, or student loan payments, then all one half of your income can go towards your house. A two thousand five hundred dollar house payment is what you could qualify for.
Let’s say you have a five hundred dollar car payment. This drops your max payment to two thousand. Easy right? Now FHA, it works the same as above. The big difference though is that if you have a better credit score, you can go a bit higher than 50% of your income. I’ve seen these approved up to 56%.
Now there’s one last, very important, thing you must know before we’re done with this part. For both the conventional and FHA loans we just covered, they each have an automated system lenders will run your loan application through, that can lower the allowed debt to income percentages we talked about above. They get lowered based on other risk factors.
So the 50 and 56 percent of your income towards your home and other debts, is not guaranteed. The risk factors that can lower these, are typically a combination of some of the following: A low credit score, high debt balances, spotty work history, and other items in your application that pose a risk. Typically it’s not just one thing. But what is known as layered risk, or multiple risk factors, that will lower the allowed debt to income ratio.
This is why it’s always important to talk to a lender. They can get your whole picture and run it through these systems to ensure the exact amount you can afford. Other concerns I’ve heard in 17 years of doing this: “Nick, I get paid funny. Does that change anything?” If your salary or full-time W-2 employment, typically no. We can use the rules above.
However other types of income like self-employed, part-time, second jobs, contract work, commission employment, bonus income, babysitting, giving blood, etc. We’re gonna need a two year average. In any of these cases, it’s best to talk to a pro to make sure you’re doing it right. As the rules can be nuanced for different loan boxes.
Wow! That’s a lot!