Here’s my “rule of thumb”: People can qualify for a loan which is between 4 and 5 times their gross income. I’ve been doing loans for almost 20 years and I use this simple formula throughout the day. It’s really easy. No silly 40% income-to-debt ratios. No PITI calculations!

Here’s an example:

Let’s assume you have 2 people earning $45,000/year each ($90,000 total). The maximum mortgage would be 4.5 X $90,000 = $405,000! There, that’s it. Wasn’t that easy?

At this stage, you simply put the amount of money that you’ve saved (yes, you need to save money!) on top of this loan amount and you’ll have the approximate purchase price. So, let’s assume you have $45,000 for the downpayment, here are the numbers:

4.5 X $90,000 = $405,000 + $45,000 = New home price of $450,000.

Now, there are a many variables which will make the above formula NOT work. High credit card debt, numerous educational loans and car loans are examples of how someone’s debt load can really affect your ability to buy a new home. Also, Fannie Mae and Freddie Mac have strict rules regarding income so my “rule of thumb” is overly simplistic but it will give you a general idea.

You can use my formula in reverse if you ask: “How much income do I need to buy that $600,000 house?”

Assume a 10% downpayment of $60,000. Here are the numbers:

$600,000 - $60,000 = $540,000 (new mortgage amount)/4.5 (my rule of thumb) = $120,000 income per year. So, you need about $120,000 of annual income to buy a $600,000 house with 10% down.

If you have a lot of monthly debt payments, you’ll need to use the lower end of my “rule of thumb”. The qualifying usually falls between 4 and 5 but use the lower range if you have a lot of debt.

There you go…. You now have the “secret” formula for figuring what you can afford in a new house. As I said above, there are many different elements to qualifying so this only a “ball park” estimate. It’s best to sit down with a mortgage professional so they can run some numbers specific to your situation.

Ken Doss

Community West Bank

Santa Barbara, CA

kdoss@communitywestbank.com

Thanks for the post, Ken! Really helpful (and easy to remember).

ReplyDelete-Daniel

Actually, lending is fairly simple if you know all of the tricks. Ha!

ReplyDeleteKen, I like the simplicity of this formula. I'm glad I'm already in my home. Even at today's rates I'd be locked out I think.

ReplyDeleteGreat rule of thumb--thanks for the post!

ReplyDelete