Association of Military Banks of America

National Homeownership Month:  Determine Mortgage Affordability – How much can I qualify for?

Amy Miller, AFC®          

National Homeownership Month is designated as a time to recognize the value of homeownership for American families. Homeownership is considered part of the American Dream and a way to build financial stability and wealth. For the month of June, we’ll be covering topics related to housing and homeownership.

A home is one of the largest purchases most of us will make in our lifetime. Determining what is affordable is a key step in the home-buying process. It’s important to be realistic and recognize the difference between what you can spend on a home and what you can spend and still live comfortably.

Unfortunately, many families underestimate the costs associated with homeownership and can find themselves significantly burdened when their mortgage, maintenance, and other expenses strain their budget. According to last year’s Military Family Advisory Network’s (MFAN) Military Family Support Programming Survey, approximately 60% of military and Veteran families report paying more than they can afford for housing, creating a burden on their families.

With that in mind, this week we’ll break down the factors that determine how much a buyer can qualify for and reasonably afford when purchasing a new home.

Factors that Determine Affordability  

There are a few key factors that lenders use when calculating mortgage affordability:

  • Credit Report & Score:  Payment history and credit scores included in an individual’s credit report from each of the three credit reporting agencies (Equifax, Experian & TransUnion) help lenders determine creditworthiness, how much can be borrowed, and the interest rates and fees that will be charged to the consumer.  Credit score requirements vary by lender and the type of mortgage, but generally range from 500-700, with most lenders requiring a minimum score of 620 to qualify. It is possible to get a mortgage with a score lower than 620, however, lower scores will often result in higher interest rates and less attractive terms.
  • Income:  Proof of all funds received regularly, including salary, investment income, rental property, part-time jobs, side hustles, etc. will be required for all applicants. Proof can be provided by submitting pay stubs, an IRS W-2, or tax returns. This helps create a baseline for what the buyers can afford to pay monthly. Lenders want to see that borrowers can repay the loan, regardless of creditworthiness. There isn’t one set income requirement or minimum to qualify for a mortgage. Requirements will vary by lender and the type of mortgage, with many offering mortgages designed to meet the needs of individuals of all income levels.
  • Debt to Income Ratio (DTI): All monetary obligations, including credit cards, auto loans, student loans, utilities, groceries, etc. will be compared to total monthly pre-tax income to determine a buyer’s DTI.  DTI is calculated as a percentage and is a comparison of what’s coming in and what’s going out each month. Lenders use this ratio to determine if a buyer is financially able to take on another monthly debt.

Lenders look at two different DTI ratios when evaluating mortgage affordability: 

*Front End Ratio is the percentage of monthly income that will go toward the mortgage payment, including taxes, insurance, HOA fees, etc.

*Back End Ratio is the portion of total monthly income needed to cover all debts and obligations, including mortgage, credit cards, auto loans, child support and student loans.

Acceptable DTI ratios vary by lender. Generally, mortgage payments should not exceed 28% of total monthly income (front end), although individuals with higher credit scores may qualify for a higher debt ratio. Back-end ratios of 36% or below are ideal; however, higher ratios may also be approved on an exception basis.

Mortgage lenders typically hesitate to work with buyers with high DTI ratios. Someone with impeccable credit but too many monthly obligations could seem risky to a lender and may not be approved.

  • Downpayment: The amount of money available for a down payment and closing costs will influence a lender’s decision on approval and amounts financed. Although a larger downpayment can make a borrower more attractive to lenders, there are programs available that offer down payments as low as 3%.  For example, VA loans give service members and Veterans no money down options as long as the purchase price is lower than the value of the home.

For more information:  There are many calculators available online that can help estimate what is an affordable monthly mortgage payment based on an individual’s financial situation. Housing counselors are also available through the U.S. Department of Urban Development (HUD) and can be accessed online or by calling (800) 569-4287. The Consumer Financial Protection Bureau (CFPB) also offers a search tool that can be used to find Housing Counseling services across the country.