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FHA Mortgages: What’s Considered an Affordable Payment?

by Gina Pogol
April 13th, 2010

Trying to figure out how much house you can afford? Sorry, there’s no magic number. But you can try several sources. You can use a general rule of thumb, input your data into a mortgage calculator, have a loan officer run your application through an automated underwriting system (AUS), or get a human underwriter to look at your file. But don’t overlook the highest authority–your gut.

The Rule of Thumb
Everyone has a favorite rule for home buying. One really common one is that you shouldn’t finance more than three times your annual income. This rule doesn’t take current mortgage rates into account. If you earn $50,000 a year, that means you can finance up to $150,000 under this rule. Your gross earnings are $4,167 per month. At a 5% interest rate, you’d have a payment of $805 plus taxes and insurance. If they were $200 a month, your housing expense would be just over $1,000 a month, or less than 25% of your gross income. By most underwriting standards, you could actually qualify for a considerably higher loan. This very general rule also ignores your other expenses. Which brings us to…..

Mortgage Calculators
Debt-to-income ratios are mortgage calculator territory. Your proposed housing expense, including mortgage principal and interest, hazard insurance, property taxes,  mortgage insurance (when required), and HOA dues (if applicable), divided by your gross (before tax) income equals your front- or top-end ratio. Mortgage calculators may set 28% as the desirable value for this ratio. Your back- or bottom-end ratio is all of your consumer loan payments, like student loans, credit cards, auto loans, and other obligations (but not utilities or other living expenses) divided by your gross income. Mortgage calculators frequently put at 36%.  If your lender says you have an ugly back-end, it means your expenses are too high. What did you think it meant?

AUS Does Not Mean Australia
Automated underwriting systems (AUS) go into more detail. They adjust the amount you may qualify for up or down depending on your credit rating, assets, job stability, and down payment. These all influence how high a ratio an AUS considers acceptable, but according to Fannie Mae’s guidelines, with enough compensating factors, a back end ratio of 50% may be approved.

Human Beans!
Human underwriters have more latitude. FHA guidelines direct its underwriters to consider many things when analyzing applicants’ ratios. Front-end ratios of 29% or less and back-end ratios of 41% or less are automatically okay. However, compensating factors allow the underwriter to approve loans with considerably higher ratios. Here are some of them:

1. You have demonstrated the ability to successfully pay housing expenses equal to or more than the proposed monthly housing expense.
2. You have demonstrated the ability to save money and use credit sparingly.
3. You have the potential for increased income (only a human underwriter will know that you just graduated from medical school!).
4. You have at least three month’s reserves after closing on the home.
5. Your housing expense won’t increase substantially.
6. You have transferred and your spouse is unemployed but looking for work.
7. Your other debts are very low, allowing you to manage a higher house payment.
8. Your down payment is at least 10%.

Payment Shock
Payment shock is one factor that underwriters (human and automated) account for, and you should too. Payment shock is your current payment versus your proposed payment. For example, if your rent is $1,000 per month, but your proposed house payment is $2,000 per month, you may be approved for a smaller loan than you would be if your current payment is $1,800 per month.

Consider Your Lifestyle (No One Else Will)
Only you know how well a proposed mortgage payment will work with your life. A lender may approve you for a lot more than you should spend. Only you know if you’re planning on starting a family and scaling back to one income, or that you like to blow your extra cash on flying lessons, or give it away to charity, or that a couple of times a year your stash goes to off Vegas…and usually stays in Vegas…

So use the above tools to  ignore the rules and run it by your gut. Rules of thumb are great, but only if you’re buying thumbs.

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This entry was posted on Tuesday, April 13th, 2010 at 2:17 pm and is filed under . You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.

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