Preapproval letters typically begin stating that a home buyer has been qualified or preapproved to buy a home priced at specific amount. What it really boils down to is how much mortgage payment the home buyer qualifies for based on the borrowers monthly income and the debt to income ratio that is being allowed by the program guidelines. Your proposed mortgage payment determines the loan amount that you’re qualified for. Add the funds to cover your down payment less the closing cost and you’ll have the sales price.
What is viewed first is the borrowers gross monthly income and current debts or monthly payments. These factors will limit how much of a total mortgage payment someone can qualify for. There are actually two ratios that lenders look at, the front ratio (proposed mortgage payment) and the back ration (proposed mortgage payment plus current debts).
For example, if a couple have $6,000 in gross monthly income and the allowed debt to income ratio is 38/45, then the most the new proposed mortgage payment can be is $2,280 (6,000 x 28%) and the most all their monthly debts (including the new mortgage payment) can be is $2,700. Remember, we’re talking gross monthly income (pre-tax and other deductions you may elect).
The $2,280 figure above includes the principal and interest, property taxes, home owners insurance, private mortgage insurance as well as any home owners association dues.
Property taxes and home owners insurance are estimated prior to having a property identified and an insurance binder. I use 1.25% of the sales price divided by 12 months to determine an estimated property tax for homes in the greater Seattle area. Some areas, like north east Tacoma, may find their property taxes are greater than 1.25% and other areas, like Bellevue, may be less. It’s an estimate.
Should you decide to buy a condo and suddenly have to factor home owners association dues or rates rise higher than expected, one option is putting more money down so that your loan amount is reduced to the payment you qualify for.
Condominium home owners association dues can be expensive and cut into how much someone may qualify for. For example, if the dues are $300 per month with a condo, that means that the buyer qualifies for $300 less per month with their mortgage. It’s no different than factoring in a car payment. $300 of a payment (home owners association dues, car payment, etc) equals about $60,000 in qualifying power or loss there of. If someone qualified for a $200,000 mortgage on a house, they would probably qualify for a $140,000 mortgage on a condo if it has dues of $300 per month (based on a 30 year fixed rate at 4.5%).
Preapproval letters should include the total payment that a borrower is qualified for. Especially in a rapidly changing rate environment that we’ve been in lately. If a borrower qualifies for $2,280 total mortgage payment which was available when rates were 4.000% and if rates are at 4.500% when they’re ready to lock, they either need to buy down the rate or have a lower loan amount.
It’s imperative that you let your mortgage professional know if your plans have changed with anything that impacts your financing, including what type of home (single family dwelling vs. a condo, for example) or how much down payment you’re planning on. Before you present an offer on a home, you may want to check in with your mortgage originator to have them review property taxes and current rates to make sure that your preapproval is still valid, especially in a volatile rate environment.
Stay tuned for Part 2 of this series where I’ll discuss down payments for buying a home.
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