With a reasonable credit score, a stable income and work history, and sufficient assets, most borrowers today can get preapproved for a mortgage. But how do you determine what you can actually afford?
Fannie Mae and Freddie Mac look at two ratios as a percentage of your income: housing (principal, interest, taxes, insurance, mortgage insurance, and condo fees) and total debt (housing debt plus other monthly minimum payments such as student loans and car and credit card payments). Often you can get preapproved with total debt ratios of up to 43 percent.
The 43 percent debt-to-income ratio is part of the test to see whether the mortgage will be considered a qualified one. These rules protect borrowers and lenders in case of default.
But is it wise to buy up to the preapproved level? It depends on your circumstances. Using your total debt obligations in the calculations leaves out many expenses that can really take a bite out of your budget. Some of these are food, clothing, transportation (other than lease or auto payments), day care, health care, gas, electric, oil, water, cable, Internet, mobile phones, and contributions to retirement and college funds. When you determine the impact of these expenses on your monthly budget, you may find yourself with a much smaller cushion.
Lenders look at gross income, not net, so federal and state income taxes and Social Security and Medicare deductions are not considered when qualifying.
To avoid being “house poor,” I advise my clients not to exceed a housing ratio of 25 percent and total debt of 33 percent. This can be challenging, however, in more expensive housing markets like Greater Boston.
For example, according to Zillow, the median home price in Greater Boston is about $425,000. My comfort level of housing debt (not more than 25 percent of income) would require an annual income of $107,000, assuming a 30-year fixed rate at 4.25 percent, a 20 percent down payment, as well as taxes and insurance. This would leave about $700 a month for other debt.
You can make less and still get preapproved, but even at a 33 percent housing debt level you would need to make $81,000 annually.
Although there is often a strong desire to buy as much home as possible, it is best to do what is safer: use a lower percentage of your available income. No one wants a borrower to get into a loan that may end up in foreclosure, and part of that is setting up safe and reasonable buying expectations.