How to determine what home price you qualify for

It used to be that people would say that you can qualify to buy a home three times your annual salary…this is actually not really the case. When qualifying to buy a home (i.e. get a mortgage) lenders consider your income, monthly debts and the amount of funds you have for down payment and closing cost.

Basically, you qualify for the mortgage payment, which determines the total loan amount and the funds you have available for down payment are essentially added to the loan amount to come up with a sales price. This is VERY basic… let’s take a closer look.

Step 1: Your income and potential mortgage payment. Mortgage programs have different underwriting guidelines as far as how much mortgage one can qualify for. Most programs will allow 45-50% for a total debt to income ratio. This means that if you take 45% of your gross monthly income (before taxes, insurance, retirement, etc.) and deduct your monthly debts, the end figure is how much your total proposed monthly mortgage payment could be. The total monthly mortgage payment includes the principal and interest, property taxes, home owners insurance, private mortgage insurance (if any) and home owners association dues (if any).

For example, if your gross monthly income is $4,000 and you have $350 in monthly debts (car payment, student loans, credit cards, etc.), then you would qualify for a total monthly mortgage payment of $1450.

  • $4000 x 45% = 1,800
  • $1800 – $350 = $1,450.

If you’re preapproved for a total monthly mortgage payment of $1,500 and the property taxes for that home are higher than what was estimated or your home owners insurance comes in higher than estimated, it’s possible that it may impact your loan approval. I always recommend that my clients contact me before submitting an offer on a home so that we can review the property taxes with current interest rates to make sure they’re in good standing with their loan preapproval.

Step 2: Figuring out the mortgage loan amount. Now that we know that the home buyer qualifies for a $1,450 mortgage payment, we can determine what loan amount they qualify for. The $1,450 includes property taxes, home owners insurance as well as possibly mortgage insurance and/or home owners association dues. Let’s assume the monthly cost for those items come to $350 ($300 for monthly property taxes and $50 for home owners insurance) and the principal and interest portion is $1,100.

Depending on the amortization and term of the mortgage (30 year fixed, 20 year fixed, 15 year fixed, adjustable rate, etc.) that $1,100 principal and interest portion of the payment will determine what loan amount the borrower will qualify for. A 30 year fixed mortgage will allow you to qualify for a higher mortgage loan amount than a 15 year fixed mortgage as the 15 year fixed mortgage has a much higher payment than the 30 year fixed even though the 15 year fixed typically has a lower interest rate.

EDITORS NOTE: Rates quoted below are EXPIRED and no longer valid. For a current mortgage rate quote for your personal scenario, please click here.

For this example, let’s use a 30 year fixed conventional mortgage. If we take the principal and interest portion of the mortgage payment, $1100 and use a 30 year fixed mortgage with an interest rate of 4.250% (APR 4.443%), the loan amount would be about $223,605. For this post, we’ll round the actual loan amount to $224,000.

It’s important to keep in mind that mortgage rates vary too. Mortgage interest rates change daily – sometimes several times a day in a volatile market. So if you’re preapproved for a total payment of $1,450 and interest rates jump higher, it may reduce the loan amount you qualify for.

Step 3: Determining what sales price you qualify for. You also have to factor in the closing cost, reserves and prepaids in addition to the down payment for buying a home. This home buyer has managed to save up about $60,000. This means that she will be able to avoid private mortgage insurance and put 20% down payment towards. This means that she can buy a home priced around $280,000 with a $56,000 down payment. When we factor in closing cost, reserves/prepaids (property taxes, home owners insurance and prorated interest), she will actually need closer to $65,464 for total funds for closing. This amount does not include any property inspection (it does include the estimated appraisal cost). If she does not have the extra $5,464 above the $60,000 that is earmarked for buying a home, she can try to negotiate having the seller contribute towards closing cost, see if she can get a gift from a family member, borrow against her 401k or for this amount, we could also look at pricing the interest rate higher to create a rebate credit to be applied to towards closing cost.

So the basic calculation for this is:

Sales Price = the loan amount (determined by the mortgage payment you qualify for) plus down payment (your total funds for closing minus closing cost, prepaids and reserves).

EDITORS NOTE: Rates quoted below are EXPIRED and no longer valid. For a current mortgage rate quote for your personal scenario, please click here.

NOTE: Interest rate quoted is of  8:30 am on 5/21/2019 and is subject to change and credit approval. 4.250% is priced with 1.177 points with an APR of 4.443%. Rate based on a credit score of 740 or higher with a sales price of $280,000 and a loan amount of $224,000 for a 30 year fixed conventional mortgage. 

I know you might be asking “what if I don’t have that much saved for down payment”. There are many low down payment options available – including mortgage programs that offer down payment assistance.  In that case, there would most likely be mortgage insurance (unless it’s a VA mortgage) which would need to be factored into qualifying for the mortgage.

If you are considering buying or  refinancing a home in Bellingham, Bellevue, Bremerton or anywhere in Washington state where I am licensed, I’m happy to help you.  Click here to start the preapproval process or here for a no-hassle mortgage rate quote scenario. 

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