It seems so simple: You have a certain amount in your mind that you feel is reasonable to spend on housing, and you want to be a homeowner. However, many factors affect what your mortgage payment will be. Some are within your control and some aren't, but making some simple calculations now will help you avoid disappointment later.
Your Housing Payment, Otherwise Known as PITI
Your housing payment as considered by mortgage lenders isn't just the principal and interest payment, but also includes your property taxes and insurance, plus sometimes association fees and mortgage insurance. Property taxes vary among communities. Property insurance does, too, especially if you'd like to consider a large home or a home with a feature such as a pool or security alarm. Remember to include each component of PITI (principal, interest, taxes and insurance) in your housing payment budget.
Before calculating affordability, estimate what you think you'll need to spend on property taxes and insurance, remembering those elements are key factors in PITI. You'll also need to estimate your interest rate. If you have excellent credit and will be putting at least 20 percent down, allow yourself a very competitive rate. If you're putting less down or have average or good credit, make the interest rate a point or two higher. You may also wish to include a sum for association fees or mortgage insurance.
The web offers several financial calculators, such as Lending Tree's "Home Affordability Calculator." You don't have to register with the site or provide contact information, and it's free to use. Simply enter your pretax (gross) income, your down payment, other monthly debt payments (auto loans and credit cards), estimated insurance, property taxes and interest rate, and the site will provide the mortgage information you seek.
Front- and Back-End Ratios
The affordability calculator at the Lending Tree site computes your front- and back-end debt ratios. These ratios are tools that underwriters use to determine how much home you can afford. The front-end ratio is your housing payment -- PITI -- and the general rule of thumb is that this number should be no more than 28 percent of your gross monthly income. However, in high-cost areas, this may be raised. To figure this number yourself, simply divide PITI by your gross monthly income.
The back-end ratio is the sum of PITI plus your other monthly debt obligations, such as auto loans, credit card minimum payments, and student loans, divided by your gross monthly income. Generally, back-end ratios shouldn't be higher than 36 percent (again, higher ratios are allowed in high-cost areas).
Factors Affecting PITI
The cost of the home and your down payment are the two biggest factors that affect PITI, but don't overlook the other elements. Property taxes, especially in an expensive area, can easily total more than $1,000 per month. Insurance on riskier homes may cost hundreds of dollars more. Of course, if you've fallen in love with a home, you may already be beyond the sway of reasoned argument.
The final critical factor in determining home affordability is your credit history. It's very simple: low scores equal high risk, and therefore high rates. It may be worth waiting a few months before applying so you can improve your score, since it could save you tens of thousands of dollars over the life of the loan. It may even make the difference between an approval and a rejection.
Lisa Bigelow is an independent writer with prior professional experience in the finance and fitness industries. She also writes a well-regarded political commentary column published in Fairfield, New Haven and Westchester counties in the New York City metro area.