Q; We are thinking about buying our first house this spring. I know you have recommended in past columns that we should get pre-approved for a mortgage before we start house hunting. But before we do that, we would just like to get a rough idea of what we could afford to decide if it is even feasible to start shopping for a home. Is there a simple calculation or rule of thumb we can use to give us a quick, rough estimate of how much house we can afford? – C.J., Everett
A: There are many different loan programs available today, so it is virtually impossible to come up with one simple rule that applies to all homebuyers. For example, a few years ago, only veterans could get a no-down-payment home purchase loan, using the government-backed VA loan program. Today, anyone with good credit can get a zero-down payment conventional mortgage to buy a home.
But having said that, there is a simple formula I have used for many years that will give you a rough idea. The calculation depends on current mortgage interest rates. When 30-year fixed rate loans are about 7 percent range, as they are today, I use a multiplication factor of three. You multiply your gross annual income by three to arrive at the approximate maximum loan amount for which you could qualify. For example, if your combined annual income were $50,000, you could qualify for about a $150,000 loan. If you earned a combined $80,000 per year, you could qualify for a loan amount of approximately $240,000 (3 x $80,000).
But again, let me emphasize that this is a very rough estimate of your buying power and should not be considered the final word. In fact, if you have excellent credit, you can probably qualify for a much larger mortgage than this rule of thumb would indicate. That’s because lenders now consider your credit risk score to be the single most important factor in determining how much you can afford to borrow.
Your credit risk is determined by using a complex computer model to analyze a variety of factors in your credit record including your payment history, the amount owed on your current accounts, how long your credit accounts have been established, whether you have recently applied for new credit, and whether you have a “healthy mix” of credit accounts. The computer program analyzes all this information and produces a three-digit number known as your credit risk score. A score of 700 or better is considered to be excellent credit.
Besides your credit, another very important factor in determining your maximum home price is the amount of cash that you have available for the down payment and closing costs. For example, if you had enough income to qualify for a $150,000 mortgage, but you also had $100,000 in the bank, you could afford to buy a $250,000 house (excluding closing costs for simplicity).
Another factor that determines how much you can qualify for is the type of loan for which you are applying.
For example, rather than a traditional 30-year fixed rate loan, you might choose “2-1 buydown” loan. That is a 30-year fixed rate loan in which the interest rate is “bought down” 2 percent the first year, 1 percent the second year and then fixed for the remaining 28 years of the loan term. For example, at approximately the same closing costs as a 7 percent 30-year fixed rate loan, you could get a 2-1 buy-down loan starting at about 6 percent. You would pay an interest rate of 6 percent the first year, 7 percent the second year and 8 percent for the remaining 28 years of the loan. Obviously, that final 8 percent interest rate is far less attractive than a 7 percent fixed rate loan, but the lower 6 percent starting rate allows you to qualify for a larger loan amount.
For example, the monthly loan payment on a $150,000 mortgage at 6 percent would be $899.32, while the payment at 7 percent would be $997.95. While that $98.63 difference in monthly payments may not seem like much, it may make the difference between qualifying or not qualifying for the loan amount you want if your income is not sufficient at the higher payment.
There are far too many other mortgage qualifying factors to cover in this brief column, so I would recommend that you find a good mortgage loan officer and discuss all your options in detail. Then you can get “pre-approved” for a loan amount and you will know exactly how much you can afford.
The simple rule method of multiplying your income by three is only useful for determining the ballpark home price range in which you should be shopping. For example, if you earn a combined $40,000 per year and have $20,000 in cash, you should not be looking at $250,000 homes because you simply cannot afford them.
Mail your real estate questions to Steve Tytler, The Herald, P.O. Box 930, Everett, WA 98206. Fax questions to Tytler at 425-339-3435, or e-mail him at economy@heraldnet.com
Steve Tytler is a licensed real estate broker and owner of Best Mortgage, Inc. You can visit the Best Mortage Web site at www.bestmortgage.com.
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