How To calculate your mortgage payment affordability
By: Rick Contrata
How to calculate your mortgage payment affordability is another installment of our series of How To Tutorials. After 25 years in the financial industry, I'd have to say that, "How do I calculate my mortgage payment affordability"? is the most frequently asked question I've heard from most first time home buyers. Fortunately for you...
When you finish reading this tutorial you'll wonder, "What the heck was the big mystery about how to calculate your monthly mortgage payment affordability." Many assume it's a complicated mathematical process, but in reality, it's ridiculously simple once you have two pieces of information. You won't need to contact your lawyer, your banker or your real estate agent to get a rough idea of where you stand in the housing market food chain either. Let's get started with a few definitions…
A Quick Mortgage Payment Glossary
Mortgage payment affordability - The ballpark maximum amount that a bank will lend based on gross income and current outstanding debt. There are exceptions and we'll get to them later.
PITI - Acronym for Principle Interest Taxes and Insurance.
28/36 Ratio - The standard formula for mortgage affordability. Simply stated, it means that the total of PITI should be no higher than 28% of gross monthly income and the total of PITI combined with all outstanding debt should be no higher than 36% of gross monthly income.
PMI - Acronym for Private Mortgage Insurance. Required when your down payment is less than 20% of the sale price.
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Mortgage payment affordability tutorial
First, establish your yearly gross income. Be prepared to furnish prior year tax returns and current W-2's to support the basis of your income. For educational purposes, let's say your annual gross income is $60,000.
Divide your yearly gross income by 12 to arrive at your gross monthly income. Using our $60,000 example, the calculation looks like this $60,000 ÷ 12 = $5000.
The $5000 figure becomes the basis for the 28/36 ratio. Simply multiply your $5000 monthly gross income by 28% or .28. The calculation looks like this.
$5000 X .28 = $1400. The $1400 represents the front end of the 28/36 ratio. Which means based on income of $60,000, you can afford in the ballpark of $1400 a month for principle, interest, taxes and insurance (PITI).
Next, go back to your $5,000 gross monthly income and multiply it by 8% or .08. The calculation looks like this: $5,000 X .08 = $400. That $400 figure represents the back end of the 28/36 ratio and it means that all of your current outstanding debt cannot exceed $400 a month. Current debt would include credit cards, car and student loans etc.
In a nutshell, a bank will allow you to spend approximately $1800 total for your mortgage and outstanding debt, based on a $60,000 annual income. $1400 per month or 28% of monthly gross income for PITI and an additional $400 a month or 8% of monthly gross income for all your other debt, total: $1800. $1400 is your mortgage payment affordability.
Exceptions that influences lenders when making mortgage loans
Other income - If you receive income from sources like bonuses and part time jobs. You'll usually have to show these income sources have contributed to your income for at least two years prior to your mortgage application for it to be considered.
Credit history - Everybody knows that your credit report can influence your application and even the interest rate that you'll pay. Get a copy of your credit report and clean it up if there are problems or discrepancies.
Potential debt - Potential debt is the debt that you could incur if you were to max out your current credit lines. Basically, it's the difference between your current outstanding balances and your total credit lines. An example would be a credit card with a $10,000 credit limit and a $500 outstanding balance. Get rid of unused credit lines or lower them to reasonable levels.
Association fees - These fees are common in condos and townhouses. They will be figured as part of your monthly mortgage payment because they are not voluntary expenditures and a necessary monthly expense associated with these types of real estate.
PMI - Another monthly expense that would be added to your monthly mortgage payment. PMI is required when putting less than a 20% down payment.
Now that you know how much of a mortgage payment you can afford based on your income and some of the factors that can influence your lenders loan decisions, you can hit the street knowing the price range of the home you can afford.
PS…Don't forget to check around for the current interest rates as any move in rates up or down can raise or lower your mortgage payment affordability.and that's why we've got a simple mortgage calculator at the bottom of this page. Check it out…
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Disclaimer: The information and the accuracy of the interactive calculator on this web page are provided as a self help guide only. This information and it's accuracy in no way replaces the expertise and guidance of industry professionals.
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