First home buyers: How much can I borrow?

by Darwin on September 24, 2012

By Betsy Falwell

“How much can I borrow?” It’s the first question you’ll hear from first home buyers. Before they think about anything else – like the location of their first home or the type of floor plan they want – they need to know the maximum amount of money they can get from a lender.

It’s a complicated question, and before you ask your financial institution for an answer, make sure you’ve got all the information necessary to get an accurate one.

Calculating Your Debt

One of the key factors that determine how much first home buyers can borrow is debt. Your lender will want to know how much debt you hold, including:

  • Auto loans
  • Student loans
  • Credit card debt
  • Mortgage debt (this obviously won’t apply to first-time buyers)
  • Medical bills
  • Payday loans
  • Alimony or child support

This isn’t the whole list, but it gives you an idea of the wide variety of debt that plays into this equation.

Calculating Your Income

Think your income is the amount of money your employer deposits in your account every other Friday? Think again. When it comes to calculating your income for mortgage purposes, lenders actually give your bottom line a boost. What lenders want to know when it comes to asking “how much can I borrow?” is your gross monthly income; that’s your income before taxes, medical insurance premiums, or 401(k) contributions. If you’re a traditional employee who receives a W-2, you’ll find this information in Box 3 of your W-2. If you’re self-employed or receive a 1099 form, calculating your gross income is a little more complicated. In this case, your lender may give you credit for more than the income stated on your 1099 if you claimed work-related deductions on your tax returns.

Additionally, your income may also include:

  • Income from rental properties
  • Dividends, trusts, or investments
  • Alimony or child support

Front-End Debt-To-Income

Once you have all this information, your lender will use it to calculate your debt-to-income ratio. There are actually two of these numbers: a front-end DTI and a back-end DTI.

The front-end DTI is a calculation comparing your overall housing expenses – including your monthly mortgage payments, homeowners insurance, taxes, and HOA fees – to your gross income. These days, lenders want to see a front-end DTI ratio at or below 33 percent, meaning your monthly housing expenses represent no more than a third of your gross monthly income. So say, for example, that you and your spouse bring in a combined $5,000 a month in pre-tax dollars. That means your maximum monthly housing costs could be 33 percent of that, or $1666.67.

How Much Can I Borrow?

Consider these factors:

  • 3.75% interest rate on a 30-year fixed loan
  • $4,000 in property taxes
  • $1,500 in homeowners insurance premiums
  • 20% down payment

In this scenario, you’d qualify for a loan of $326,000, which would bring your monthly payments to right at $1,666. But if interest rates go up – or your projected down payments goes down, forcing you to pay for private mortgage insurance, or PMI – you’d qualify for less to stay at that same monthly payment level. For example:

  • 4.5% interest rate on a 30-year fixed loan
  • $4,000 in property taxes
  • $1,500 in homeowners insurance premiums
  • 10% down payment, resulting in PMI at a rate of 0.52%

Under these circumstances, that same $326,000 loan would cost you more than $2,000 a month. To stay under that $1,666 level, you’d qualify for no more than $244,000.

Back-End Debt-To-Income

The second ratio lenders use is the back-end DTI. This compares your overall debt – including housing – to your gross monthly income. Lenders want to see this number at or below 41 percent, although some lenders like to see that ratio even lower. So say, once again, that you and your spouse bring in a combined $5,000 a month before taxes – you’re looking at a maximum $2,050 in monthly debt. Since we know the maximum housing debt (based on front-end DTI) this couple could carry would be $1,666 a month, in this example the first home buyers could have no more than $384 in non-housing debts like car or student loans before it would reduce the amount they could borrow.


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