Buying a House in 2008: How Much Can You Afford?
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Today marked the beginning of an exciting new adventure for the Schaefer family, buying our first house. We will be moving to Washington this summer where I will be flying C-17’s for the Air Force. We should be stationed there for at least 4 years, just long enough where buying actually makes sense.
For the past several months I have been studying home buying (trying to be one of Ramit’s other friends), reading books, blogs and asking questions to people who have some experience in the area. I’ve learned quite a bit, but realize there’s still much I don’t know. In an effort to share with my readers the info and advice that I pick up along the way, I present a new series of posts called Buying a House in 2008. The goal of this series is to share the lessons I learn as I go through the long and sometimes turbulent process of buying a house.
Figuring Out How Much You Can Afford
Trying to buy a house without knowing how much you can afford reminds me of the episode of Seinfeld where Kramer decides to see how far he can test drive a car on an empty gas tank…neither him nor the car salesman knew how far was too far. So, earlier today I decided to call up my bank and talk to someone about getting pre-approved for a loan. By doing this I would be better equipped to search for prospective properties. This call was absolutely free and did not place me under any obligations to the lender. What I learned was, aside from the basic information (estimated price range, where we’d be buying the house, etc.) the first thing the lender must determine is your debt to income ratio. This ratio shows what percentage of your income is available for a mortgage payment after all other obligations are met.
A commonly used guide is that the total amount you pay toward your mortgage should not exceed 28% of your gross income. This number is simply a rule of thumb and the percentage is often times much higher depending on circumstances. To calculate your debt to income ratio you must know your total income. This includes your salary and any other monthly payments you receive like dividends, interest, alimony or child support payments, etc. If you are married pool your spouse’s income with your own.
After adding up your annual income, divide this amount by 12 to determine your monthly income. Next multiply your monthly income by .28 which will give you the maximum monthly payment allowed for housing expenses (mortgage payment, insurance, taxes…known as PITI). The next number used by many lenders is 36%, the maximum percent of your monthly gross income the lender allows for your housing expenses plus additional recurring debt. To find this divide your monthly income by .36. As you navigate the loan process these amounts should help you understand how much you can afford and what to expect when you talk with your lender. **A note to my fellow USAFA grads that took “the loan” - this debt alone significantly effected this ratio, so be prepared.
Example:
Annual Gross Income = $50,000 / 12 = $4,167 monthly income
$4,167 Monthly Income x .28 = $1,167 allowed for housing expenses
$4,167 Monthly Income x .36 = $1,500 allowed for housing expenses plus recurring debt.
On the phone with my lender I was told that this ratio, along with a few other factors like additional liquid assets, job security and credit score help the lender determine the amount of money they are willing to loan you. This aspect of our conversation took up the first 30 minutes and was extremely informative and beneficial. The second 30 minutes included the various types of loans available to me such as VA, conventional, 5/1 ARM, etc., as well as the actual pre-approval of the loan. More on what I learned on this topic in the next post.
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3 comments
Hey Cam,
Another good, useful, and informative blog. Keep these ones coming as I suspect that much of your reader base maybe in a similar boat. And those that aren’t should be interested in watching someone navigate the Housing Market right now.
I would like to say, however, that your first step before calling a lender would be to check your credit score and resolve any potential problems. A lender is guaranteed to check your credit score, so you don’t want unnecessary blemishes. Also, have you been able to look for homes for sale in your area that would be interested in owner financing? Seems like there could be a lot of “distressed” sellers right now. Even if its not advertised, you should ask, could save you and the seller lots of money and headache.
Great post! I wonder how much I could get approved for…not like I’m planning on buying. I don’t even have $2k set asid for a down payment!
SavingDiva,
I had a look at your blog and it looks like your doing everything necessary to afford a house in the near future, I’m very impressed with your dedication and discipline in saving and cutting costs.
The biggest factors effecting how much you’ll get approved for will be your income, debt and credit score…work at these things and it’ll all fall in place. Subscribe to Schaefer’s Blog so you don’t miss the rest of my Buying a House in 2008 series.
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