Buying you house ultimately depends on two things:
How much you have available for a down payment (starts at 3% down for some programs), and
If you fit within the qualifying guideline used by banks.
There are two qualifying guidelines that determine the amount of mortgage for which you are eligible: housing ratio and debt ratio. The lender will use the lesser of housing ratio or debt ratio as your qualifying mortgage amount.
1. Housing Ratio, 28%:
Example: If your gross monthly income is $2,000 then 28% equals $560. (2,000 x .28 = 560)
Your housing expense, $560 in the above example, consists of four components known as PITI (Principal, Interest, Tax & Insurance). Only the principal and interest components are used to determine the qualifying mortgage amount.
Example to determine Principal & Interest Payment: If your housing expense equals $560, then you must subtract an estimate for taxes and homeowners insurance. The remaining balance is the part that would be used to re-pay your loan.
The principal & interest payment ($440 in the above example) can be used by the lender to determine the mortgage amount you qualify for.
Debt Ratio, 36%:
Example: Using the same income as in the example above ($2,000 per month gross pay) your debt ratio dollar amount is $720. (2,000 x .36 = 720)
With this dollar amount you must first subtract out your other monthly debt payments such as:
(DO NOT include utility, phone, insurance or cable payments. These are considered living expenses and need not be counted as debt.)
Example: Assuming $260 in other monthly debt ($200 vehicle payment + $10 credit card payment + $50 student loan payment = $260), and using the $720 calculated above, your PITI is $460. (720 - 260 = 460)
Now deduct an estimate for taxes and insurance to arrive at your Principal & Interest amount. For example, $460 - $120 ($100 for taxes & $20 for insurance) = $340. You will use this number to calculate your mortgage amount.
To determine the approximate sale price you can afford, add your down payment to your mortgage amount.
$44,210 + $3,000 = $47,210
As you can see, the larger the down payment or the lower your other debts the "more house" you can afford to buy.
In addition to calculating housing costs and other long-term debts, lenders also order a credit report and review your repayment history.
What does a bank look for in a credit report?
If is important to keep your credit good by making sure you pay your bills by the date the payment is due and to keep credit card balances to a minimum. If your credit card balances are greater than 20% of your gross monthly income, it could make qualifying for a home loan more difficult.