Before a Realtor will show you any properties, one of the first questions you will be asked is: “Do you know how much house you can afford?”
Any mortgage lender can pre-qualify you, or tell you how much house you can afford. Potential buyers also are encouraged to get pre-approved for financing before they begin shopping.
Such pre-approval means you will have guaranteed funds available for a purchase, and can thus have added negotiating power with sellers who will know a sales contract won’t be hung up on mortgage contingencies.
But before a lender can pre-approve you, several documents need to be provided. Because loan approval will be based heavily on your financial background, the main thing you can do as a prospective borrower is to get your financial records in order.
To show your current earnings, bring stubs from each employer for the most recent 30-day period, showing your name, Social Security number and year-to-date earnings. Your employer’s name and address are necessary for income verifications to be mailed.
To show a history of your income-earning potential, bring copies of your W-2 forms from all employers for the last two years.
Signed federal tax returns with all supporting schedules also should be provided, especially in certain cases of self-employment (both business and personal returns are needed) and for borrowers dependent on income from bonuses, commissions, rental properties or interest payments.
Borrowers who receive income from alimony, child support or Social Security should provide additional documentation, such as copies of award letters from Social Security, canceled checks over a 12-month period to identify child support and court supported ledgers for proof of income for alimony or other types of income.
Divorce decrees will be required to verify child support amounts both as outgoing payments and income received.
To show your assets and prove availability of down payment, furnish the lender with the past three months’ original statements from each bank where you have checking and savings accounts. Also provide proof of ownership and value of stocks, bonds and real estate.
To help demonstrate your ability to handle credit, you’ll need addresses, account numbers, monthly payments and balances outstanding on all forms of installment debt (auto loan, credit cards, etc.)
It is helpful to have available your most recent statements from charge accounts and bank cards, so the underwriters can use the minimum required payment from the statement to calculate debt ratios.
Without them they will use a higher minimum payment (typically 5 percent of each outstanding balance) to calculate outgoing debt outlays per month.
You will need canceled checks for the last 12 months if you are renting; or last year-end account statement plus canceled checks from year-end to the present from your mortgage holder. Include your lender or landlord’s name and address.
Mortgage information will appear on your credit report. If there are discrepancies, having canceled checks will resolve the issue of late payments quickly.
Once you’ve provided this information, a lender can determine the maximum mortgage loan amount you can afford.
A common rule-of-thumb is that a maximum of 28 percent of your total gross income (income before taxes) should go for housing debt (monthly payments, interest, taxes and insurance); a maximum of 36 percent of your gross income should go for all monthly installment debt including housing.
Government insured Federal Housing Authority loans stretch these ratios to 29 percent and 41 percent, respectively.
Community Homebuyer programs, which are geared to the first-time homebuyer, also stretch these debt-to-income ratio guidelines beyond the standard 28 percent and 36 percent.
A potential borrower who makes $36,000 a year before taxes and has $300 in monthly debt expenses, would have monthly gross income of $3,000.
Based on the 28 percent housing debt-to-income ratio, the borrower could afford monthly housing expenses of $840. Based on the 36 percent total debt-to-income ratio, the borrower can have monthly debt obligations (including housing) up to $1,080.
By subtracting the extra monthly debt expenses of $300 from the total allowable debt amount of $1,080, the borrower is now only qualified for monthly housing expenses of $780.00. Assuming monthly real estate taxes of $150 and insurance costs of $50, the borrower is qualified for a loan payment of $580.
By using a 30-year fixed-rate mortgage at a rate of 7.25 percent, this buyer could borrow about $85,000 to purchase a home.
Most Realtors and home-listing publications have simple charts that can give borrowers a rough estimate of what they can afford. But the lender’s decision will take into account total financial situation.
For example, a stable job, steady annual increases in income or a large down payment can weigh in your favor. The 28/36 ratios can be stretched beyond the rule-of-thumb figures if you’re a good risk.
Not all lenders adhere to the same borrower financial guidelines; so don’t get discouraged if you get turned down by the first lender you approach.
If after several lender conversations you still come up empty, try contacting a mortgage broker. Most mortgage brokers deal with a multitude of lenders; so there is a good chance that they know of a lender amenable to your situation.
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Jim DeBoth is president of Mortgage Market Information Services. Address your questions to Mortgages, c/o the Chicago Tribune, Real Estate Section, 435 N. Michigan Ave., Chicago, Ill., 60611. Sorry, we cannot accept questions over the phone and will not give personal replies.
