In the first article, called Mortgage Finance Basics – Part I, we discussed the 3 pillars of qualification – credit, income and assets and that the biggest factor in determining your client’s purchase price is his or her total debt-to-income (DTI) ratio. This is calculated by dividing your client’s current monthly minimum debt payments to include their new proposed mortgage payment (total housing payment including principal, interest, taxes, insurance, and maintenance fees/association dues – AKA PITIA) by their total gross monthly income (income before taxes and deductions for salaried and hourly buyers and adjusted gross income (AGI) AFTER expenses for self-employed and 1099 buyers).
Here again are the typical DTI guidelines for Conventional, VA, FHA, and USDA loans. *Please note: the information provided below are general concepts and guidelines for each loan program and the actual characteristics available to your home buyer may be different based on their specific credit profile and qualifications.
- Conventional (loans underwritten and approved under Fannie Mae and Freddie Mac guidelines): max 50% total monthly debt to include proposed PITIA.
- VA (Veterans Administration for qualified Veterans): roughly 50% but depending on strength of buyers credit and assets, can go as high as 60-70% debt to income ratio. For initial pre-qualification, always go with 50% to be conservative.
- FHA (Federal Housing Administration): use 50% DTI for this one.
- USDA (Dept of Agriculture Rural Development Loan Program): 43% for total DTI and separately 32% max for PITIA as a percentage of the home buyer’s total gross monthly income. MUST meet both requirements.
In this article we’ll dive deeper into calculating estimated total housing payments for your clients and determining if they will qualify for the price range of the homes they are interested in so you can better tailor your buyer’s home search to the proper price range.
The first item you will need is a good mortgage calculator, one that not only calculates principal and interest, but one that will allow you to enter in estimated property tax, homeowner insurance, and maintenance fees/association dues (if applicable). There are many mortgage calculators available online or through the App Store or Google Play to help you easily calculate a total PITIA payment for your clients. I personally use Karl’s Mortgage Calculator app and recommend you obtain a good mortgage calculating app for your smart phone so that you can quickly and easily calculate an estimated housing payment for your client. This is especially helpful if you are out showing your client properties in the evening or on the weekends when reaching a mortgage loan officer is more difficult. This way you can provide the necessary information to your client on the spot without relying on being able to reach anyone else.
Once you have selected a mortgage calculator, practice calculating payments on several MLS listings in your area. On most, you’d just enter the purchase price, down payment percentage, interest rate and term (30 years), and then the monthly/annual homeowners insurance and property tax and it will automatically calculate the total estimated housing payment.
For example, if you are looking at a listing for a $400,000 single family home with $250 per month in property taxes and estimated $150 per month in homeowners insurance, you can calculate the total payment as follows if your client has 20% down:
*Use Karl’s Mortgage Calculator or other preferred mortgage app to calculate the Principal and Interest and then add in the Property Taxes and Insurance.
$320,000 loan amount at estimated 4.5% 30 year Fixed interest rate:
$1621 Principal and interest
$250 property tax
$150 insurance
Here is what it looks like on Karl’s Mortgage Calculator app:
The total housing payment would be approx $2021. You do not have to be exact with this numbers, that is the lender’s responsibility. Your goal is to get an approx idea of the monthly total payment and be able to provide that information to your buyer on the spot with him or her understanding that they’d need to speak with their lender to get more specific details about interest rate and terms based on their specific situation.
If you know that your client earns $6000 per month in gross salary, then you can figure that with conventional financing, their maximum total debt cannot exceed $3000 per month (50% of the $6000 gross income). If they have $400 in other minimum debt payments per month, then you can assure them that they’d likely qualify for the payment on this single family home as the total monthly debt would be approx $2421 ($2021 for PITI and $400 for other monthly debt). You can calculate their total debt-to-income ratio (DTI) by dividing the $2421 by their $6000 monthly income, which equals 40.4%.
Based on their income of $6000 per month and their monthly debts of $400, you know that their maximum total housing payment would be $2600, calculated as follows:
$6000 X 50% = $3000 Max Total Monthly Debt Payments
$3000 – $400 = $2600 Max Total Housing Payment
You know that they would qualify for the $400,000 single family home described above, but how do you know what their maximum purchase price could be assuming they have 20% to put as a down payment?
Here is where the fun math begins! But, it is basic math and can be done on a regular calculator 🙂
First, based on current mortgage rates in the low to mid 4% range, we can estimate that the principal and interest (P&I) payment will be approx $500 per month for every $100,000 in loan amount.
Then we just need to subtract the monthly estimated property tax and insurance from their maximum housing payment to determine the amount remaining for P&I. We can use the same $250 amount for property tax and $150 for homeowners insurance and it is calculated as follows:
$2600 Max Total Housing Payment – $250 Property Tax – $150 Homeowners Insurance = $2200 remaining per month for Principal and Interest (P&I).
We now divide the remaining P&I of $2200 by the $500 per month per $100,000 in loan amount and are left with 4.4. This 4.4 number translates into $440,000 in maximum loan amount at current interest rates so that the P&I on a 30 year fixed loan does not exceed $2200 per month. Here is the calculations for that:
$2200 / $500 = 4.4 which translates to $440,000 Max Total Loan Amount
Finally, to determine the maximum purchase price based on a $440,000 maximum loan amount with 20% down payment, we divide the $440,000 loan amount by the loan to value (LTV) which is 80% with a 20% down payment and calculate as follows:
$440,000 / 80% = $550,000 Max Total Purchase Price
If you are able to obtain a few key pieces of information from your prospective home buyer during your relationship building process with them, you can help them determine approximately what purchase price range would work for them and help you tailor your home search to fit their needs and desires within that price range.
Practical Exercise – Calculate maximum monthly housing payment for a conventional loan based on the following:
- Husband and wife buying together and they both work in salaried positions. His gross income is $3500/mo and hers is $4500/mo.
- They have an auto loan payment of $400/mo
- She has student loan payments of $100/mo
- They have approx. minimum credit card payments of $200/mo
Practical Exercise – Calculate approx. maximum monthly housing payment for a VA loan based on the following:
- Active duty buyer with spouse and no children. His total monthly gross income with BAH, COLA and BAS is $7000/mo.
- They have $700 per month in auto loans.
- They have approx. minimum credit card payments of $200/mo
The total loan to value of 102.15% is used with VA financing to take into account the cost of the VA funding fee (2.15% is used for active duty and veterans first time use of VA – most common). If your Veteran client has at least 10% VA disability, then this fee may be waived and the max purchase price would be the same as the max loan amount with 100% financing.
Ultimately, everything is dependent upon the needs and desires of your buyer and their current financial position. This short cheat sheet guide is just a reference for you to use to help your buyers determine their approx. purchase price range and monthly payment amount as you initially build your relationship with them. Any good lender will explain all of the above to your buyer during the pre-approval process however, there are times when your prospective client doesn’t meet with a lender within the first few weeks or months of developing a relationship with them. These calculations are a way for you to demonstrate to the buyer your versatility and knowledge in all facets of the purchase process and can be their trusted source of a wide range of real estate expertise until they take that next step to get pre-approved by your favorite lender.
Below are some additional resources to learn even more about the mortgage loan process that your client must traverse today.
- Freddie Mac Step-by-Step Mortgage Guide from Application to Closing: http://www.freddiemac.com/singlefamily/docs/Step_by_Step_Mortgage_Guide_English.pdf
- Consumer Financial Protection Bureau Consumer Home Loan Toolkit: https://files.consumerfinance.gov/f/201503_cfpb_your-home-loan-toolkit-web.pdf
- Definition of an ARM Loan: https://www.consumerfinance.gov/ask-cfpb/what-is-the-difference-between-a-fixed-rate-and-adjustable-rate-mortgage-arm-loan-en-100/
- Discount Points and Lender Credits and How They Work: https://www.consumerfinance.gov/ask-cfpb/what-are-discount-points-and-lender-credits-and-how-do-they-work-en-136/
- VA Condo Approval List: https://vip.vba.va.gov/portal/VBAH/VBAHome/condopudsearch
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