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by: Scott Schang, FindMyWayHome.com

According to the most recent Housing Affordability Index (http://www.car.org/marketdata/data/ftbhai/), nearly two-thirds of Californians can afford to purchase an entry level home.

Affordability is more than just a word, especially when you hear it in the context of reports like this that are based on price averages, median incomes and 10% down payment.  Being able to realize the American Dream of Home Ownership is too important to rely on statistics and analytics.

Here is a simple guide to help you understand how to calculate how much you can afford, and a few tricks you can use to increase your affordability.

 

Debt to Income Ratio (DTI)

Your Debt to Income Ratio is what determines how much home you can afford.  Simply put, it’s the percentage of your gross income that is committed to paying the debts on your credit report, and your proposed housing payment.

The next step is calculating your Gross Income.

 

Gross Income Calculation

Your gross income is what you make before taxes and deductions.  For most W2 employees, the gross income from your W2 is all you’ll need to start with.

Self-employed homebuyers must use the written down, net taxable income from your tax returns, averaged over two years.

Add in your proposed mortgage payment of $1750 (hypothetically)

Now, we calculate debt.

 

Calculating Debt

The debt portion of your debt to income ratio comes from your credit report.

Note:  If you have student loans that are deferred, proof that it will be deferred for at least 12 months is required to not have to include in debt to income ratio.  Also, if you have an auto loan with less than 10 months left on the installment loan, that payment can be taken out of your calculation.

 

Calculating your Debt to Income ratio

The calculation for finding your debt to income ratio is pretty actually:  Debt / divided by Income = DTI

 

Example of Debt Calculation

Car:                 $400
Credit Cards:  $300
Debt Calc:       $700

Proposed Payment: $1,750

 

Example of Income Calculation

Gross from W2:   $55,000
Divide by 12 to get gross monthly income
Gross Monthly:  $4,583

(Debt $700 + House Payment $1,750) = $2,450 / Income $4,583 = .5345

You have a back end DTI ratio of 53% (front end DTI is housing payment only).  Your housing payment includes taxes, insurance, mortgage insurance and HOA insurance if any apply.

 

Maximum Allowable DTI for Common Loan Types

• FHA:  56% with automated underwriting approval
• VA:  41% but may be flexible with compensating factors
• Conventional:  45% with automated approval / 50% with compensating factors

Based on the above example, here is what you’ve found out:

1. You could look at ways to decrease your debt
2. You can lower your price range so that your payment decreases
3. You can simply use a FHA insured mortgage allows up to 56% DTI

Important: Your debt to income ratio is just one of many factors that go into establishing eligibility for a home loan.  While the calculations are accurate, there are many factors that go into calculating the debt, and the income that are used for determining your final DTI.

Use this as a rule of thumb and consult a licensed loan officer about qualifying.