#where can i get a loan
How much home can I afford? and
Our How much home can you afford? page gave you a rough idea of the maximum price you can afford to pay for a home, with an easy-to-use calculator. The page you’re reading now gives you more of the story behind those numbers, and helps you better understand the factors influencing how much money the bank will loan you. This won’t necessarily help you compute your borrowing power any better (that’s what the calculator is for), rather it’s just to help you understand the concepts behind those numbers better. This discussion isn’t absolutely essential for most homebuyers, but it’s provided for those who want to know as much as possible — especially those having trouble affording a home who want to look for way to improve their house-buying chances.
Of course, if you haven’t already gone through the basics of how much home you can afford and haven’t used the calculator then you should go back there now before reading any further the page you’re on now is the advanced stuff.
Okay, on with the advanced stuff.
You’ll remember the simple formula from the previous page — since you pay for your house with a combination of a down payment and a bank loan, the total of both is the cost of the home:
Down Payment + Biggest Loan You Can Get = How Much Home You Can Afford
You know how much you can afford for a down payment, so that part’s easy. (At least you should know — if you don’t you should probably figure that out before going any further.) So that leaves us with finding the biggest loan we can get. So really, the rest of this page is really How much loan can I get? and not How much home can I afford? To find how much home you can afford just add the amount you can afford for a down payment to the amount you can get for a loan.
We’ve left one thing out of our simple equation above — closing costs . You’ll need to either pay the closing costs from your savings (lowering the amount you have available for a down payment), or qualify for a loan that’s a little larger than the house you want to buy, and have the closing costs added to the loan.
Returning our focus to getting the biggest loan possible, here are the things that can get us a bigger loan:
- Higher monthly income
- Lower existing monthly debt payments
- Bigger down payment
- 30-year mortgage (vs. 15)
- A better credit score
- A lower property tax insurance rate
Let’s look at each of these in detail.
Higher Monthly Income. Obviously the more you can afford to pay for a home, the bigger the loan you can get. The bank limits your monthly mortgage payment (including taxes and insurance) to no more than 28 to 36% of your monthly income. What determines where you fall on that scale is the size of your down payment and your credit score. In any event, the higher monthly payment the bank allows, the bigger the loan they’ll give you.
This 28 to 36% figure is called the Housing Ratio. For example, if you make $3000/mo. and the bank uses a housing ratio of 33% then the bank figures you can afford $990/mo. in mortgage payments ($3000 x 28%). Note that the amount you can borrow is also limited by how much debt you have. Just because the Housing Ratio says your payments can be up to $990/mo. any debt you have couldbring that figure down. We’ll cover that later on.
Usually there’s not much you can do in the short-term about your income, but in one case there is: Buy a duplex or a house with a separate garage apartment that you can rent out. Then you can count the amount you’ll collect in rent towards your income. Some lenders are finicky about counting the rental income, but you can almost certainly find one who will. Your chances improve if the space is already rented and the renter has a long-term lease. Being able to count this extra rental income can help you buy a more expensive home — which will be a much better investment.
Here’s an example of how having a higher income means a bigger potential loan amount. These are estimates of loan amounts available at various income levels, assuming: $10,000 down, $500/mo. in debt, 7% interest, 30-year mortgage, and 2% property taxes and insurance.
Lower Monthly Debt payments. The less money you already owe, the bigger the loan you can get. The bank limits your monthly mortgage payment (including taxes and insurance) to no more than 36 to 42% of your total monthly debt, including your mortgage payment. This figure is called the Debt Ratio. For example, you make $3000/mo. have $500/mo. in debt, and the bank uses a debt ratio of 38%. They limit your total monthly debt to $1140 ($3000 x 38%). But you already have $500/mo. in debt, so that means you have $640/mo. left over for your mortgage payment.
What determines where you fall on the 36 to 42% scale is the size of your down payment and your credit score. In any event, the higher monthly payment the bank allows, the bigger the loan they’ll give you.
Note that the amount you can borrow is also limited by the housing ratio discussed above. The bank figures your monthly limit using the Housing Ratio, then they figure your limit using the Debt Ratio, and they take the lower of the two. Here are some examples, with your monthly limit in each case highlighted.