Lenders determine affordability based upon a combination of factors including your gross monthly income, debt and current and future monthly payments to creditors. As that’s just one of the areas lenders evaluate it’s certainly one of the most important. Lenders make money on the interest collected from the loan and they want to make sure they’ll get paid back on time, every time. Ability to repay has been an oft-used term by lenders who review the debt-to-income ratio. That said, how much money do you need to make to buy a home?
That obviously depends upon you and how much you make each month. But data service HSH Associates did some major data scouring last year and came up with some figures that might surprise you. HSH took various data points regarding median home value, prevailing interest rates, principal and interest payment along with a monthly amount allotted for property taxes and insurance. After reviewing the data, the most affordable place to live was back east, specifically Pittsburgh, PA. The most expensive? You guessed it- right here in California.
HSH figured those who live and buy in San Diego need to make an annual salary of at least $109,440 to finance a home with a mortgage. Los Angeles was a bit lower at $92,000 yet up in San Francisco, where the highest annual salary was needed, the figure comes in at $161,967. According to HSH, the average borrower would have to make at least six figures in different California cities. It’s not really a surprise for those who live here that home values are higher compared to other parts of the country while median family income is also higher.
Okay, so you do live in San Diego County but you don’t quite make $109,440 per year? What does that mean exactly, that you have to sit on the sidelines? Of course not. The HSH analysis looked at values overall compared to other empirical data. Your ability to repay is calculated in the very same fashion as someone who makes $1 million or $50,000 per year. In fact, for conforming loans, lenders are required to perform an analysis to make sure your own debt-to-income ratios do not exceed 43. If a loan is approved and the total debt ratio is at or below 43, the loan receives protection from future litigation as the loan then conforms to standards labeled “Qualified Mortgage” or QM.
The number 43 is actually expressed as a percentage. Total debt includes the mortgage payment including principal and interest, property taxes, insurance and mortgage insurance when needed. In addition to the mortgage payment other monthly credit obligations are added in. These additional payments are those for minimum credit card payments, student loans, installment loans with more than 10 months remaining and other debt which appears on a credit report.
The lender then compares those monthly payments with gross monthly income and if the credit payments represent 43% or less of gross monthly income the loan can receive QM status. In addition, QM status must also mean the loan term cannot exceed 30 years, no “interest only” payments allowed and limits on the amount of points and fees that can be charged.
Okay, now let’s use those calculations and look at how much salary one needs to make in order to buy and finance a home. We’ll work backward and come up at an annual income requirement.
Let’s say there is a home listed at $350,000 and the borrowers are going to make a 20% down payment, or $60,000 for a mortgage amount of $290,000. They have a new car payment of $650 and student loans totaling $240 per month. Total installment debt is then $890. They have now other debt.
They select a 30 year fixed rate loan with an interest rate of 4.50%. Property taxes are $3,000 per year and insurance $1,500, or $250 and $125 each month respectively. The principal and interest payment on $290,000 at 4.50% is $1,469 for a total mortgage payment of $1,844. Adding the car payment and student loans to this comes to $2,734.
If the maximum total debt ratio is 43, that means the borrowers would need to make about $6,500 per month, or $78,000 per year. This is similar to how HSH came up with their numbers but they went about it in a different manner. Instead of picking out a particular property they used median home values for the area and prevailing interest rates.
While such data mining is interesting to read what’s more important is how it relates to you. Lenders will approve you based upon previously established lending guidelines and compare your monthly debt to income as they have been doing for years.
Will You Have Enough?
We realize we’ve thrown in a lot of numbers here and we know it’s sometimes hard to read. But if your eyes glazed over for just a bit wading through all the ratios, taxes and mortgage payment, we apologize but did think it important enough to point out how HSH came up with the numbers they did. At first glance, especially for someone who has yet to apply for a first mortgage, they could see the HSH report and erroneously conclude they don’t make anywhere near enough each year to qualify for a home loan when we’ve just shown you that’s not the case.
Even though lenders use similar guidelines when evaluating a mortgage loan application there are really no two borrowers exactly the same. And because mortgage rates are dynamic and can change daily, the final data is also susceptible to error. The HSH report was fun to read and a bit eye-opening but remember you’re the only one that matters when you speak to your mortgage lender. You’re not a statistic. You’re a client.
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