How Much Mortgage Can You Afford?

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For anyone thinking about purchasing a home, it’s the most fundamental question: How much mortgage can you afford?

Put another way, with today’s interest rates, tough underwriting rules and the down payment cash that you can put together, what mortgage amount might a lender approve you for, given your income, debts and credit scores?

Many home shoppers opt for a “quick fix” answer by visiting websites that provide an online calculator. That’s fine. But simply entering your monthly income, expenses and what you believe to be your credit score in a computer program won’t accurately predict what a specific lender will actually agree to lend you.

More important, it won’t give you insights into the often flexible. Or case-by-case factors that lenders can use to get your loan application approved.

Here’s an overview of what really matters to lenders and how you can more accurately predict whether you’ll qualify for a given loan amount or not.

Mortgage Secret #1: Ratios are hugely important.

Every mortgage lender uses debt-to-income (DTI) ratios to arrive at a baseline judgment about your financial capacity to repay a loan. The idea is to measure your gross monthly household income and compare it to two types of debt:

The money you spend each month on core housing-related expenses combined;
And the amount you spend on non-housing debts, such as credit cards, auto loans, student loans, etc.

If you need to devote too high a percentage of your monthly income to pay off debts, then you may not have enough left over for food, clothing, transportation and other essentials. To a mortgage lender, that means (statistically, at least) that a buyer will likely fall behind on mortgage payments.

For example, say your monthly gross income before taxes and other deductions is Kes 60,000. If your monthly payments for housing-related and other debt total Kes 30,000 — an overall DTI ratio of 50%. Most lenders will tell you that you need to lower that ratio significantly.

To calculate your debt to income, lenders typically focus on these two specific ratios:

Your Housing Ratio:

How much will your key housing-related expenses total per month and what percentage of your income will they represent?

Your key housing costs include:

Principal, Interest, property taxes and hazard insurance on the loan you’re applying for;
A homeowners association, condominium or cooperative fees that you are required to pay;
Any additional fees required for your mortgage or property, such as flood insurance or mortgage insurance premiums.

Say your housing costs are projected to come to about Kes 10,800 a month and you and your partner or co-owner earn a combined gross income of Kes 60,000 a month. That’s a housing ratio of 30%. Most lenders will consider that (and even slightly higher) as acceptable, provided your total debts are not too high.

Your Total Debt Ratio:

Of the two ratios, this is more important. A lender will take your total housing expense and add all other recurring debt payments that you have. Including credit cards, auto loans or leases, personal installment loans, student loans, child support and alimony payments.

Take the Kes 60,000 gross income example above. If your total debt payments come to Kes 24,600 a month, your DTI is 41%. That should be acceptable to most lenders. Debt payments of Kes 27,000 would take your total debt ratio to 45% and probably make you borderline for many lenders. At 50% or higher, most buyers would be turned down for a conventional loan, but some might qualify for an FHA insured-backed mortgage.

Mortgage Secret #2: Loan types matter a lot.

For most new buyers, the type of mortgage they choose will greatly affect what they can afford. Mortgages in Kenya come in two main forms:

Fixed-rate mortgage

As the name suggests, a fixed-rate mortgage is a type of homeownership loan that has a fixed interest for the duration of the loan. The loan has a term of between 15 and 30 years. When you borrow it, the interest will not fluctuate throughout the length of the mortgage. In other words, you will be making the same amount every month until you pay off the loan.

Adjustable/Variable Rate Mortgage

An adjustable or variable rate mortgage is a type of loan that has a changing interest rate. The rate tends to change periodically. In essence, the initial interest given by the lender is always lower on an ARM than on a fixed rate home loan. But in the long term, the rate can go up anytime. How much that can increase is unpredictable. As such, ARM is a riskier form of financing for houses over time.

When obtaining the loan, the lender will set an initial period, typically 3-7 years. Within this period, your interests will remain the same. But after that time elapses, your loan will start to adjust as the rates fluctuate. That means after the initial period where the rate was the same, it will start going up or down. Adjustments sometimes occur once every year.

The Biggest Mortgage Secret: Automated Underwriting

Though most home buyers are unaware, the success of their mortgage applications — and thus their ability to buy a home — rests with two national online computer models that flash tens of thousands of “yes,” “no” or “maybe” responses to lender inquiries every day.

Automated underwriting can also increase your ability to buy a home because it searches for bright spots in your application that could counteract or outweigh negatives. It makes underwriting more flexible than a set of rigid rules. It’s the reason why a 45 or 50% DTI can get approved.

Skilled loan officers can get your application approved by adjusting the application “mix,” such as raising your credit score by having you move balances on certain debts or finding ways to raise your eligible income.

One note of caution: Don’t allow yourself to commit to a loan amount that will strain your monthly budget.

Other key points

Income:

Your eligible “income” may be more than what you think. It’s not just what’s on your W-2s. Say you make a little extra money from a side business or receive additional income via rents, royalties, regular investment income or capital gains, alimony or child support payments, an automobile allowance from your employer, or rent from boarders.

These types of additional revenue are all potentially includable to boost your loan amount, provided that you can document them and they are stable and continuing.

Credit Scores:

Credit scores can be killers. Some lenders won’t approve applicants whose credit scores are below 640, 660 or even 680. If they do accept such scores, some lenders may hit homebuyers with heavy extra fees.

Related: How To Build Your Credit Score

Closing Costs:

Don’t forget to factor closing costs into any calculations you make. Depending on where the property is located, it can account for anywhere from 2 to 5% of the total home purchase transaction.

Now you know how much home a mortgage lender thinks you can afford. While that number is useful, and you should not try to exceed it, it also makes sense for you to apply your own standards. Just because a bank says you can qualify for a given amount does not mean you should automatically borrow that full amount.

As the owner of both your income and debt, you can and should factor in your own thoughts. For example, perhaps you have a college education or a wedding to fund in the future for a child. While the underwriting processes described above won’t reflect such future expenses, you can and should consider them, as well.

With the advice above in mind, you should be better equipped for research. And ultimately to decide what mortgage payment that you and your lender feel you can afford each month.