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There are two basic formulas commonly used by
lenders to determine how much of a mortgage you
can reasonably afford. These formulas are called
"qualifying ratios" because they estimate
the amount of money you should spend on mortgage
payments in relation to your income and other
expenses.
It is important to remember that the following
ratios may vary from lender to lender and each
application is handled on an individual basis.
The guidelines are just that -- guidelines. There
are many affordability programs, both government
and conventional, that have more lenient requirements
for low and moderate income families.
Many of these programs involve financial counseling
for low and moderate income people interested
in buying a home and in return, offer more lenient
requirements.
Generally speaking, to qualify for conventional
loans, housing expenses should not exceed 26%
to 28% of your gross monthly income. For FHA loans,
the ratio is 29% of gross monthly income. Monthly
housing costs include the mortgage principal,
interest, taxes and insurance, often abbreviated
PITI. For example, if your annual income is $30,000,
your gross monthly income is $2,500 x 28% = $700.
So you would probably qualify for a conventional
home loan that requires monthly payments of $700.
Any expenses that extend 11 months or more into
the future are termed long-term debt, such as
a car loan. Total monthly costs, including PITI
and all other long-term debt, should equal no
greater than 33% to 36% of your gross monthly
income for conventional loans. Using the same
example, $2,500 x 36% = $900. So the total of
your monthly housing expenses plus any long-term
debts each month cannot exceed $900. For FHA the
ratio is 41%.
Maximum allowable monthly housing expense
26% - 28% of gross monthly income - Conventional
29% of gross monthly income - FHA
Maximum allowable monthly housing expense
and long-term debt
33% - 36% of gross monthly income - Conventional
41% of gross monthly income - FHA
One way to determine how much to spend for housing
is to compare your monthly income with monthly
long-term obligations and expenses.
When budgeting to buy a home, it is important
to allow enough money for additional expenses
such as maintenance and insurance costs. If you
are purchasing an existing home, gather information
such as utility cost averages and maintenance
costs from previous owners or tenants to help
you better prepare for homeownership.
Homeowner's insurance or property insurance is
another cost you will have to consider. The lending
institution holding the mortgage will require
insurance in an amount sufficient to cover the
loan. However, to protect the full value of your
investment, you might want to consider purchasing
insurance that provides the full replacement cost
if the home is destroyed. Some insurance only
provides a fixed dollar amount, which may be insufficient
to rebuild a badly damaged house.
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