Though you may be willing to spend a certain amount, the real determination of how much house you can afford is driven by how much a lender calculates you can afford. So before you begin to search for the perfect house, it is very important to begin the homebuying process by getting preapproved. Getting preapproved for a home mortgage loan will provide you with a preliminary statement on the size of loan for which you can qualify. Knowing this, you can then focus your home search.
In general, lenders allow your total monthly housing costs to go as high as but not more than 30 percent of your gross monthly income. The second requirement is that not more than 36 percent of your gross monthly income can be tied up in the total monthly house payment and payments on long-term debt.
Lenders use slightly different formulas for determining the “total monthly house payment.” These costs generally include the mortgage principal and interest payment, property taxes as a monthly sum, and hazard insurance as a monthly sum. These four items are referred to as PITI (principal, interest, taxes and insurance). Other costs may be included in this calculation if your down payment is less than 20 percent or if you are responsible for homeowner’s association dues. The calculations may vary from lender to lender, but will provide you with a gauge.
The Preapproval Letter
Your friends and family may know you to be reliable, dependable and someone who pays bills on time, but all others in a real estate transaction will require you to prove it. That’s where preapproval comes in. A preapproval letter is more reliable than a pre-qualification letter. In the preapproval process, a lender will examine your finances and will make a preliminary statement on the size of the loan for which you’ll qualify.
Preapproval is an involved process. The lender will take all pertinent information regarding your finances and perform an extensive check on your current financial status. This procedure will ultimately give you the exact loan amount that you will be eligible for (depending on what type of loan you decide to select.) Being preapproved lets the seller know that you have gone through an extensive financial evaluation and there should be no unexpected obstacles to buying the home. It makes your offer much more powerful.
Preapproval gives you a very good indication of:
- How much down payment you’ll need
- Your closing costs
- Your monthly payment (including PITI: principal, interest, taxes and insurance)
- The type of loan for which you qualify and which best suits your needs; and,
- Special programs for which you may be qualified, including those for veterans, first-time buyers, teachers, etc.
To become preapproved you will need to provide a lender with the following:
- Your employment and income history (including recent pay stubs)
- Your monthly debts
- The amount and source of cash available for the down payment and closing costs
Preapproval letters are not binding on the lender, they are subject to an appraisal of the home you want to purchase and are time sensitive. If your financial situation changes, interest rates rise or a pre-determined date passes, the lender will review your situation and recalculate your maximum mortgage amount accordingly. You can research lenders yourself and ask them to preapprove you.