The maximum amount of money that a mortgage lender will allow you to borrow
depends on two tests. The first test, which could be called
the allowable monthly housing cost test, ensures that your monthly
mortgage payments will not exceed 28% of your gross annual income. The second test,
which could be called the allowable total monthly debt payment test, ensures
that your total monthly payments for all debt including your mortgage payments
do not exceed 36%. These ratios are good things because they help people to avoid
overextending themselves. For example, if you bring home $2,000 per month and
had to make a $1,500 mortgage payment each month, it is virtually guaranteed
that you would either starve to death or default on your loan. The first test tries to
prevent this from happening. In the same way, if you have a number of outstanding
loans for cars, boats, furniture, etc. and tried to load another large loan on top
of the pile, then it is also likely that you would eventually default. Test 2 guards
against this problem.
The first calculator on this page helps you to calculate your 28% and 36%
ratios. Subsequent calculators help you to determine the monthly
payment for your mortgage, the total monthly payment for the mortgage
plus all additional expenses (you can then compare this number with the
allowable monthly housing cost), and your total monthly debt payment (you can compare this
number with the allowable total monthly debt payment).
So, now that you know your limits, let's see how your borrowing
needs fit into them. First we need to calculate the monthly payment
for your loan. Use the calculator below to do this.
Now you know your monthly mortgage payment. You must add to this number insurance costs, city
and county taxes, and any monthly fees. Doing this will give you your total monthly
cost of owning a home. Use the calculator below to do this.
Now you know your Total Monthly Cost of home ownership. You must add to this number all other debt payments
to determine your total monthly debt load. Use the calculator below to find your total monthly debt load.
If you look at all of these numbers and everything looks good, then congraulations! You
are well on your way to home ownership. If you find that you are falling short, here are
some things to try:
Reduce your expenses and debt - Several of the previous articles in this series talk about
lowering your expenses. To buy a house you also need to reduce debt. You might be able to do
this by selling your car (if you are driving a new one). You can then pay off its loan and
eliminate the monthly payments. Buy a much less expensive used car to replace it.
Work to pay off other debt - Pay down all other existing loans (see other articles
in this series for advice) to eliminate debt and monthly payments on it. Start saving the
extra money this frees up each month.
Save a larger down payment - By saving a larger down payment you reduce the size of
the mortgage you have to apply for. You may also be able to eliminate PMI if you can
accumulate a 20% down payment.
Wait for interest rates to fall - If interest rates are relatively high, you may be able
to wait a year for them to fall.