How Much House Can I Afford?

How Much House Can I Afford?

Of all the questions that I field each week, this is by far the most common:  how much house can I afford?

What does the industry mean by “Affordability”?   It is simply whether the house payment, along with the borrower’s other debt obligations, will be at a level where the borrower will not be in financial distress, possibly resulting in missed payments or foreclosure.

So isn’t affordability calculated in the same way for all types of loans – FHA, VA, Conventional, etc.?
No, although it is similar, there are distinct differences for each loan type.   As to similarities, all loan programs include the loan payment, property taxes, insurance, and PMI premium in the borrower’s housing debt calculation.  And all lenders include the borrower’s other debt payments, including charge card minimum payments and installment loan payments in the debt ratios.  Beyond that, there are differences in how much debt a borrower is allowed to carry.

What are the conventional loan guidelines?  Both conventional and FHA loan guidelines require two debt ratio calculations.  The first ratio is the percentage of a borrower’s gross income it takes to make the house payment.  The second ratio is the percentage of a borrower’s gross income it takes to make the house payment plus all other debt payments.  The general guidelines are 28% for the housing ratio and 41% for the total debt ratio.

How do VA and USDA differ?   They both utilize a single debt ratio calculation that includes housing and other debt.  The general guideline for that total debt ratio is also 41%.   However, VA has a further affordability calculation called “residual income”.  Depending on the Veteran’s family size, after all debt service there must still be enough income left over to provide for reasonable living expenses.  The residual income calculation includes regional charges for utilities, and other items that are not considered by the other loan types.

Is there any flexibility in the debt ratio requirements?   Conventional loans provide the most flexibility by utilizing “compensating factors”, and will allow both ratios to exceed guidelines where the borrower has other strengths such as high credit scores, significant savings, etc.   Conventional lenders will also let the housing ratio go to 36-38% if the borrower is not carrying much other debt.   FHA is less flexible in their housing ratio (generally allowing 32-33% max), and VA and USDA don’t care if the borrower’s housing ratio is 41% as long as there are no other debt obligations.

The introduction of the Dodd Frank rule on January 14th will ultimately cap most debt ratios at 43% regardless of offsetting factors or internal flexibilities.   I can help you calculate your Affordability Index and debt ratios, to determine the amount of house you can buy.