Published 16 November 2019
LAS CRUCES – Determining how much home you can buy before hopping into the car and embarking on loan and house shopping sprees is a very good idea. In addition to uncovering the extent of your buying power, you’ll learn enough about the qualifying process to successfully negotiate with lenders for the best loan deal. All you need to accomplish the task is a bit of information on your income, debt and credit.
A large percentage of lenders sell their loans into the secondary market, where they’re packaged into mortgage-backed securities and sold to investors — such as pension funds, insurance companies and hedge funds. The investors define the standards buyers must meet for their loans to qualify for purchase. One of those standards is the debt-to-income ratio, which reveals the percentage of a borrower’s gross income that is used to service debt.
According to many internet sites, investors prefer to purchase loans that follow the 28/36 rule. The guideline suggests that a borrower’s house payment should not exceed 28 percent of their monthly gross income (the front-end ratio), and that their house payment and other payments combined should not exceed 36 percent of their monthly gross income (the back-end ratio). In reality, the guidelines are far more generous.
In our neck of the woods, lenders regularly qualify borrowers whose ratios are in the 30/45 range and higher when a buyer is particularly well qualified. With the exception of the New Mexico Mortgage Finance Authority’s first-time buyer programs, where interest rates are the same for all applicants, debt ratios play a big part in the interest rates offered to borrowers. Again, with the exception of MFA’s one-rate-fits-all programs, credit scores also affect mortgage interest rates in a big way.
So, let’s put this knowledge to work. Let’s say a buyer wants to purchase a home utilizing the minimum down payment. For veterans and active-duty warriors, the down payment is zero. For everyone else, the lowest down payments are typically 3.0, 3.5 and 5.0 percent. Irrespective of the amount of the down payment (plus closing costs), our borrower is pretty much financing 100 percent of the purchase price. Let’s also say that the buyer’s annual income is what the census bureau reports as the median of $40,924, or $3,410 per month, for our area. The median is where half make more and half make less.
The next step is to calculate our borrower’s allowable monthly payment. We know that he makes $3,410 per month. If his front-end ratio is 30 percent, his house payment should not exceed $1,023 per month (30 percent of $3,410). If his back-end ratio is 45 percent, his house payment and other payments combined should not exceed $1,535. Theoretically, if he had no other payments, he could put the difference of $512 towards his Lambo note and still not be disqualified due to excessive debt.
The next step is to assess our buyer’s credit and reserves. The reserves are the amount of money the borrower has left over after the purchase is completed. For first-time buyers obtaining one of the MFA products, a credit 620 score is all that’s needed. For other conventional and government loan products, the higher the score, the lower the rate.
So, to what extent do credit scores affect the cost of money? In a word, bigly. According to the myFico loan cost calculator available to consumers at http://www.myfico.com/credit-education/calculators/loan-savings-calculator/, the monthly principal and interest payment on our borrower’s 30-year, fixed-rate mortgage of $127,875 ranges from a low of $574 to a high of $693 for the principal and interest portion of the monthly payment.
The final step is to convert the maximum monthly payment of $1,021 into a maximum home price. A rough rule of thumb is that borrowers who utilize minimum down payment financing pay around $8.00 per month for every $1,000 of the sales price. The amount includes principal, interest, taxes, insurance and mortgage insurance.
Revealing the max sales price is accomplished by dividing our guy’s max monthly payment of $1,021 by the $8.00 per-thousand monthly payment. The dividend is the maximum number of thousands at $8.00 each the $1,021 monthly payment will support. In our buyer’s case, the number of thousands is 127.626, which translates to a purchase price $127,626.
Borrowers who have high credit scores and decent reserves are typically allowed higher debt-to-income ratios and are offered lower interest rates. The same holds true for borrowers who have a history of paying higher-than-normal mortgage or rental payments. The allowable ratios for borrowers who have low credit scores and very little in reserves will be less generous.
Now that our borrower has figured out how much home he can buy, it’s time for him to begin loan shopping. Keep in mind that not all shoe stores offer the same shoe products, and not all lenders offer the same loan products. And, as with shoe stores, even if two lenders offer the same product, they may not price it the same. Once our borrower has made application and received approval to purchase up to a particular price, it’s time for him to begin shopping for a home.
See you at closing.
Gary Sandler is a full-time Realtor and the president of Gary Sandler Inc., Realtors in Las Cruces. He loves to answer questions and can be reached at (575) 642-2292 or Gary@GarySandler.com