Determine Budget

Mortgage lenders are chiefly concerned with your ability to repay the mortgage. To determine if you qualify for a loan, they will consider your credit history, your monthly gross income and how much cash you've been able to accumulate for a down payment. So how much house can you afford? To know that you need to understand a concept called "debt-to-income ratios."

The standard debt-to-income ratio is your housing expense, or front-end ratio, and your total debt-to-income, or back-end ratio.

Front-End Ratio
The housing expense, or front-end ratio, shows how much of your gross (pretax) monthly income would go toward the mortgage payment. As a general guideline, your monthly mortgage payment, including principal, interest, real estate taxes and homeowners insurance, should not exceed 28 percent of your gross monthly income. To calculate your maximum housing expense, multiply your annual salary by 0.28, then divide by 12 months. The answer is your maximum housing expense.

maximum housing expense = annual salary x 0.28 / 12 months

Back-End Ratio
The total debt-to-income, or back-end ratio, shows how much of your gross income would go toward all of your debt obligations, including mortgage, car loans, child support and alimony, credit card bills, student loans and condominium fees, etc. In general, your total monthly debt obligation should not exceed 36 percent of your gross income. To calculate your debt-to-income ratio, multiply your annual salary by 0.36, then divide by 12 months. The answer is your maximum allowable debt-to-income ratio.

maximum allowable debt-to-income ratio = annual salary x 0.36 / 12 months

Example
Take a home buyer who makes $40,000 a year. The maximum amount for monthly mortgage-related payments at 28 percent of gross income would be $933. ($40,000 x 0.28 = $11,200 --- $11,200 / 12 months = $933.33.) Furthermore, the lender says the total debt payments each month should not exceed 36 percent, which comes to $1,200. ($40,000 times 0.36 equals $14,400, and $14,400 divided by 12 months equals $1,200.) The following chart shows your maximum monthly payment and maximum allowable debt load based on your gross annual income (remember, gross income is pre-tax income):

• Conventional Loan:
     Housing costs: 28 percent of monthly gross income.
     Housing plus debt costs: 36 percent of monthly gross income.
• FHA & Rural Development Loans:
     Housing costs: 29 percent of monthly gross income.
     Housing plus debt costs: 41 percent of monthly gross income.

Taxes and Insurance
Lenders include the cost of real estate/property taxes and home owner's insurance when calculating how much house you can afford in a monthly mortgage payment. Your Security Realty agent can tell you the current property tax rate for the area you are looking to buy in. You must insure your new property to obtain a mortgage. Your insurance agent can estimate your homeowner's insurance for your area and price range. Be sure to inquire about special requirements for hazard insurance, such as mandatory coverage for floods or other natural disasters. Also, if you have less than a 20 percent down payment, you will also be required to obtain mortgage insurance or take out a second loan, called a piggyback loan, to bring the first mortgage down to 80 percent of the purchase price. Both alternatives will raise your monthly payment.