Suppose you’ve looked for months for a home to buy. None of the homes you’ve seen met your needs. Your agent tells you it’ll cost you more to get what you want.
You have several options. You can revise your housing priorities to bring them in line with homes in your price range. You can investigate less expensive neighborhoods. Or you can stretch to buy a more expensive home.
There are basically two ways to increase your purchasing power. One is to increase the amount of your cash down payment. For example, your parents may be willing to give you some money for the down payment.
Buyers who don’t have gift money might accumulate a larger down payment by liquidating assets. Some buyers can borrow against their 401K pension plans. A new tax law change permits first-time buyers to use up to $10,000 of Individual Retirement Account savings for a down payment without incurring early withdrawal penalties, effective in January 1998.
The other way to increase your purchasing power is to qualify for a larger mortgage. When interest rates rise, borrowers qualify for less. In this situation, switching from a fixed-rate to an adjustable-rate mortgage (ARM) helps borrowers qualify for a larger amount.
However, changing from fixed-rate to ARM when interest rates are low won’t significantly improve your purchasing power. The reason for this is that most ARM lenders qualify borrowers at a 7 percent interest rate, even though the initial (teaser) rate may be significantly lower. Therefore, your income must be high enough to afford a 7 percent interest rate, even if the starting rate is less.
Loans with MI (mortgage insurance to protect the lender from a buyer default) curb purchasing power because they increase the cost of borrowing. If you can avoid loans that require MI, you’ll qualify for more.
Another option is to convince a lender to give you a larger than normal mortgage.
Lenders frequently make exceptions when they qualify borrowers. But to get a lender to bend the rules, you’ll need to provide the lender with as much information as possible about your financial picture. You need to convince the lender that you’re a good credit risk.
When lenders qualify borrowers for a mortgage, they evaluate the borrower’s credit, employment history and debt-to-income ratio. Typically, lenders want the borrower’s projected monthly housing expense (mortgage payment, property taxes and insurance–also called PITI, which stands for principal, interest, taxes and interest) to be no higher than 38 percent of the borrower’s monthly taxable income. This is called the front-end ratio.
The ratio of the borrower’s total debt (housing expense plus other long-term debts like car payments and student loans) shouldn’t exceed 41 percent. This is known as a back-end ratio. These ratios vary by region of the country and may be much lower in your area. Check with a local lender.
If a lender approves a higher than normal ratio, this allows you to qualify for a larger mortgage and buy a more expensive home. Lenders sometimes accept front-end ratios as high as 40 to 41 percent, and back-end ratios up to 41 percent. With impeccable credit, you might get a lender to go as high as 50 percent on the back-end ratio.
Lenders make exceptions on ratios for borrowers who have good credit, assets in addition to the down payment (like stocks, bonds or retirement savings), the ability to make high monthly payments, a conservative financial style and a good savings history.
