How Much Home Do I Qualify To Purchase?
There has long been confusion regarding how a lender determines the maximum amount of home you can purchase more commonly know as your qualifying amount. The rules regarding how to calculate your qualifying amount for conventional loans are established by Fannie Mae, Freddie Mac, or your local bank if they make the loan and collect the payment. If the bank does not collect the payment then it is likely they have sold the loan and must apply Fannie Mae or Freddie Mac rules. The rules regarding how to calculate the qualifying amount for government loans such as FHA, VA or RDA are established by the federal agencies that oversee these programs. The bottom line is that the rules for determining how much you can qualify to purchase with a conventional or government loan are uniform nationwide.
There are two calculations that must be completed to determine your maximum qualifying amount:
The first calculation determines your maximum allowable mortgage payment and uses what is called the front end ratio The front end ratio,which is your proposed total housing payment, or PITI, divided by your gross monthly income cannot exceed 28% with a conventional loan or 29% with a government loan. A simple illustration of this principle would hold that a person who earns $1,000 gross monthly income would not be approved for a conventional loan having a payment higher than $280 per month (28% of $1,000); or a government loan with a payment higher than $290 per month (29% of $1,000).
After the lender has calculated your maximum possible mortgage payment with the front end ratio they must make a second calculation using the back end ratio. The back end ratio is your total monthly debt (consumer credit, child support, and proposed mortgage) divided by your gross monthly income. The back end ratio cannot exceed 36% with a conventional loan or 41% with a government loan. Using the same illustration from above, where the individual earns $1,000 per month, the maximum total monthly debt including mortgage payment could not exceed $360 (36% of $1,000) with a conventional loan or $410 (41% of $1,000) with a government loan. It is this second calculation that hurts those individuals who have large car payments, large child support payments, or other large consumer debts relative to their income. In this example if the person had a car payment of $300 per month they could only qualify for a maximum $60 monthly house payment with a conventional loan or a maximum $110 monthly house payment with a government loan. Using a loan with a low down payment you are talking about a $6,000 to $11,000 house.
The ratio which results in the lowest maximum monthly house payment is used to determine the qualifying amount. For people with little or no other monthly debt it is usually the front end ratio that determines the maximum monthly house payment. Those people who have larger amounts of debt are affected by the back end ratio. Using whichever results in the lowest monthly payment, the interest rate factor, the amount of down payment, and some assumptions regarding property taxes and homeowner’s insurance rates, your lender determines the maximum home you could qualify for or your qualifying amount. This prequalification allows you to narrow your search to those homes you are qualified to purchase.