How Much Home Can Your Clients Afford?
Everyone wants to be happy in a new home. The right neighborhood, the right floor plan, and the right sales price go a long way to maximize customer satisfaction. What you can’t control, however, is the comfort level of the buyer with their monthly house payment. Here are a few guidelines that apply when considering how much a client can afford.
Start with income
The buyer’s income divided by debt obligation establishes a baseline for what they can afford to pay. Percentages vary, but a traditional rule of thumb has been that housing payment + housing taxes + housing insurance (a.k.a. “front-end”) debt shouldn’t exceed 28 percent of the gross monthly income.
Other sources recommend that “back-end” debt—which is the total of all monthly debt payments—not exceed another rule of thumb at 36 percent of the income. Still other, more conservative, opinions will advise that housing expenses should be limited to 25 percent of the monthly take-home pay. The real question to ask is, “How much monthly wiggle room is the buyer comfortable with?”
Automated underwriting systems are used today to assist lenders and underwriters in determining the credit risk present on a file. These programs use both the front-end and back-end ratios as a component of that risk profile on a loan. These systems also take into account other factors—such as the down payment, credit score, and cash reserves.
Consider the down payment
How much money does the buyer have in reserves? Again, tradition has something to say—in the past, a down payment of 20 percent has been touted as the norm, but that’s not necessarily the case anymore.
According to the National Association of Realtors, the way that people finance homes has shifted: 74 percent of first-time buyers and 55 percent of all buyers put less than 20 percent toward a down payment; the median down payment is only 13 percent; and of all the people who bought homes, about 45 percent had a down payment of 6 percent or less.
Different loans offer increased flexibility. FHA loans allow for a down payment as low as 3.5 percent, while VA loans can support up to 100 percent financing. And depending on contributing factors like credit score and debt ratios, other loans may also offer the same features. It’s still important to note that down payments of less than 20 percent will require some sort of mortgage insurance, so that may factor into financing decisions.