How to Calculate Your Mortgage Limit

How to Calculate Your Mortgage LimitLong Beach home buyers ask a few common and frequent questions. Among these is the ubiquitous “What is my mortgage limit?”. To know how much mortgage you can afford when you are going in for a new house, you need to know that there is no fixed answer. The answer depends on the method used by your mortgage lender to calculate your mortgage limit.

There is no fixed regulation stipulating the size of the house you can buy, or the amount of your mortgage. The reason for this is that your mortgage lender will calculate your mortgage limit differently from how you would do it. Here, we will take a look at both the approaches to calculating your mortgage limit.

The Mortgage Lender’s Method – DTI to Calculate Maximum Purchase Price

The maximum purchase price calculated by a mortgage lender does not really consider the potential home’s purchase price. Instead, the mortgage lender takes into consideration the amount of mortgage loan required by the home buyer and the prevailing mortgage rates. He uses these figures to calculate the expected mortgage payment every month. This figure is compared with the monthly income of the buyer.

This method of comparison is called the Debt-to-Income Ratio. It is abbreviated as DTI and this ratio consists of two components.

Front-End Ratio of DTI

The front-end ratio of DTI is the first component of Debt-to-Income. This is a comparison of the monthly mortgage payment to be made with the monthly income of the buyer. The monthly housing payment includes the following compulsory obligations:

  • Association dues to be paid every month
  • Monthly insurance to be paid by homeowners
  • Monthly taxes of real estate to be paid
  • Monthly interest payments and principal

The front-end ratio has no maximum limit. However, mortgage lenders are likely to prefer no more than 36% of front-end DTI. That is, a buyer should have to allocate only up to 36% of his or her monthly income towards housing payments.

Back-End Ratio of DTI

The back-end ratio is the second component of DTI. This ratio pits the buyer’s monthly income against not only the monthly housing payments, but all payments that the buyer needs to make.

These might include all or more of the following obligations that the buyer has to undertake every month:

  • The minimum monthly credit card payments
  • The housing payments per month
  • In case of car loans or lease, the monthly payments towards the car
  • Child support per month
  • Monthly installments of loan payments

Banks prefer to see 43% or less as the back-end ratio. However, this does not mean that your mortgage application will automatically be disqualified if you have a DTI exceeding 36%. You can also find lenders who accept up to 45% DTI ratio and higher for FHA loans, even up to 55%.

Creating a Monthly Budget for the Household

Home buyers can leave the onus on the bank to determine the maximum home they can afford. However, they can also calculate this on their own.

The bank can tell you the maximum you can afford with respect to your income. However, your other priorities also determine how much you are willing to spend on your housing payments.

By creating a monthly budget and laying out your priorities, you can come up with the maximum amount you are willing to spend on your mortgage. By calculating backward from this amount you can zero in on the maximum loan you are willing to take on your home.

Today, if you are eyeing Long Beach real estate, and haven’t purchased — there are still good bargains out there. Give me a call, 562-257-5008 and let’s arrange for you to see how much house you can afford right now!

About Ric Dizon

Ric Dizon is a mortgage consultant (NMLS 230093) with iMortgage, a premier mortgage banker in Long Beach, California. He's in love with four things in life...being a dad, his Ku'uipo Pamela, Hawaii and finding you the right home loan. Connect with Ric on Facebook, Google+, Pinterest, Twitter and check out his Instagram photos.