Home Loan Guidance Topics

Understand What You Can Afford Ahead of Time


Stay under the lenders' risk rules

Examine your monthly expenses and determine how much you believe you can afford in monthly home payments, with some level of comfort. One rule of thumb is to look at what you pay in rent each month. If your rent payment is no problem and you have lots of cash leftover every month, maybe you can afford a higher monthly home payment. If not, your rent payment may be the best indicator of what you can afford comfortably.

One of the main rules to understand is the 28/36 rule. This one has widespread use by lenders for determining a safe level of monthly housing payments. If you don't pass the 28/36 rule, you will look riskier and get less favorable interest rates.

The 28/36 Rule: The 28

Generally, to be considered in the safest category of borrowers, lenders do not want your monthly housing payments to exceed 28% of your monthly gross income. Gross income is the amount you make before taxes are deducted and should include alimony payments, child support, dividends, interest and other sources of income, provided you will be able to prove that that income will continue for the foreseeable future.

So, let's say you make $48,000 per year in salary and bonus. That computes to $4,000 per month in gross income. The lender will not want your monthly housing payment to exceed 28% of that, or $1,120 per month. Your housing payment is made up of PITI. "P" stands for principal payment you'll have to pay back, "I" for the interest on that principal, "T" for the estimated real estate taxes divided into monthly increments, and the second "I" for insurance for the home and mortgage.

Although this can vary from state to state, and even county to county, you can estimate that the Principal and Interest (the "PI" in "PITI") is about 80% of PITI. Meaning, about 20% of your monthly housing payment can be expected to go to real estate taxes and home and mortgage insurance. If you have questions about this, it's a good one to ask in initial discussions as you interview potential mortgage sources. They can make a better estimate of how much of your PITI housing payment should be reserved for the home loan itself (Principal and Interest) and how much for Taxes and Insurance.

The 28/36 Rule: The 36

Usually, to be considered "safe," the lenders do not want to see your total monthly debt payments exceed 36% of your monthly gross income. So, add to your PITI any monthly obligations such as ongoing monthly credit card debt payments, car loan payments, child support payments and alimony that you pay, and any other similar debt. You don't include your current rent expense assuming you will be moving out of the rental apartment or house. If that amount exceeds 36% of your total monthly gross income, again you're in a trouble zone for lenders.

Stay below these levels, following the 28/36 rule and you could set yourself up for a cheaper loan. If you can't do this, it may still make sense to buy your home, but be prepared for potentially higher interest rates.

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