Buying a house for yourself or family is always a time to be very alert throughout the process and to know what is expected for all parties involved. Before making an offer on a home to buy, you need to be sure of how much you can “afford”. Your local mortgage lender should able to tell you this by reviewing your income, down payment, credit score, employment, and additional factors when applying for a loan. One of the most popular ways to indicate how much a home buyer can afford is by using a multiple of your household income on an annual basis.
Investopedia, CNN and other responsible financial media says it is 2 to 2.5 times. This can be adjusted upwards if you have a larger down payment of 40% or more.
By and large, nearly all potential homeowners will be able to afford a home that is priced up to two-and-a-half times your gross annual income.
Don’t believe us, check it out for yourself !
These numbers are derived from where? Underwriters apply the ratios below as a means to keep to loan defaults low:
- Front-end debt-to-income (DTI) ratio = housing payment costs (PITI) / gross annual income. PITI is an acronym for the mortgage principal balance, mortgage interest, property taxes, and homeowners insurance. In some cases, you’ll have HOA insurance to add to the formula.
- Back-end debt-to-income (DTI) ratio = housing payment costs (PITI) as well as all ongoing monthly debt, / gross annual income. Recurring monthly debt consists of car loans, student loans, credit card debt, plus any monthly payments for spousal and/or child-support.
Their successful formula simply assures that a borrower’s cost of housing doesn’t surpass your monthly budget or make you struggle in paying other recurring monthly debts. Many lenders follow the federal guidelines from Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA) front-end DTI limits of 31% and 43% for a back-end-ratio DTI.
We’re going to use the following relevant statistics based on Orange County, CA statistics from mid-2015:
- Household income. An online search reveals that the median household income in Orange County, CA at $101,547 gross a year, or $8,462 a month.
- Property Taxes. Based on an average home price of $591,000, property taxes are around $554/month or $6,648 for annual property taxes. ($591k x.01125)
- Homeowners Insurance. Taxes are estimated at $172/month or $2,068 for annual insurance premiums. ($591k x .0035)
- Credit card debt. Using the national average household credit card debt of $7,500 and a 3% minimum payment per underwriting guidelines, it results in a $225 payment.
- Auto Loans. National average is a $400 month car payment per household which has a new car.
- Student loans. If you have a student loan, the national average is $240 each month for paying back student debt.
- Current 30-year fixed mortgage rates for a $591,000 home, a 20% down payment, and a $470,000 loan ranges from 3.75 – 4.25%. Payment & Interest comes out to $2,312 / month at 4.25%.
The front-end ratio is $3,038 (PITI) / $8,462 Gross Annual Income = 36%
The back-end ratio is $3,903 (PITI) + recurring monthly debts / $8,462 = 46%
Under this scenario, the borrower would not qualify so the borrower needs to get a much lower rate, a larger down payment, more monthly income, or a lower priced home.
The CoreLogic Home Price Index indicates Orange County house prices continue to go up, increasing by 4.3 percent for 12 months ending June 2015,
It was the 37th consecutive month that prices rose year over year.