Think Like a Lender: It’s a Critical First Step

Most people know that discussing options with a mortgage professional is an important step to finding out how much house you can afford to buy. However, few realize that understanding what lenders look for is also critical to the home-buying process.

First, you need to calculate your current debt load and your price range. To determine your price range, your debt load is determined by two ratios – your Front End Ratio and your Back End Ratio. These limits may vary, but it’s wise to stick to the guidelines.

The first guideline is that your monthly housing costs  should not exceed 28 percent of your gross monthly income. This is the Front End Ratio. The housing cost is your monthly mortgage payments, which includes principal, interest, taxes, and insurance. Lenders add up your housing costs and figure out what percentage they represent of your gross monthly income. Note that the better your credit score, the higher your ratio can be.

Your entire monthly debt should not be more than 36 percent of your gross monthly income. This is your Back End Ratio. Again, the better your credit, the higher the ratio. Your entire debt load includes housing costs plus all other debt payments – car loans, credit card payments, loans, lines of credit, alimony, etc.

The maximum home price you can realistically afford depends on a number of other factors as well. These include your household gross monthly income, your down payment, and the mortgage interest rate.

If your calculations show that you are ready to begin the home buying process, then the next step is getting preapproved. Not only is this confirmation that you are approved for a set amount, it will also lock in a favorable interest rate.

The hardest part for many first-time home buyers is saving for the down payment. There are options available, and first-time home buyers should speak to their mortgage professional.