Mortgage & Equity

3 What Can You Afford?

This section will discuss:

The 28/36 guideline that lenders use to determine how much you're eligible to borrow.
The up-front costs you will need to pay in cash.

Figuring out what you can afford to spend on a home calls for a healthy dose of realism, not wishful thinking. Some plain old arithmetic will give you guidelines, before you start house shopping.

The 28/36 Guideline

One common guideline is that your mortgage payments should amount to no more than 28 percent of your monthly gross income (income before taxes, Social Security and other deductions). Your mortgage payment has four components: principal, interest, property taxes and insurance - commonly referred to as PITI. You can work out this calculation in Chart A - see example.

Another method says that your PITI plus your total long-term debt load (such as car payments, college loans, installment payments) should not exceed 36 percent of your gross income. Chart B shows an example.

Lenders will use the smaller of these figures, $800 in the example here, in determining how much mortgage payment you can carry. The 28/36 formula is just a guideline. Lenders may exceed the 28/36 figure if you have no debt or a large down payment. Some special low- and moderate-income home-buying programs use 33 percent and 38 percent as the qualifying numbers.

Up-front Costs

Buying a house means more than monthly payments. Up-front costs must be paid in cash; they are not part of your mortgage amount. Major up-front costs include:

Down Payment - In today's market, mortgage lenders typically require as little as 5 percent down -- and even less in certain programs. A 5 percent down payment on a $90,000 house is $4,500, which leaves $85,500 for the amount of the mortgage.

If you pay less than 20 percent down, your credit union lender might require that you get private mortgage insurance (PMI).

Closing Costs - Chief among these are "points" - various one-time fees that the lender charges. Each point is equal to 1 percent of the borrowed amount. All told, closing costs may run from 3 percent to 6 percent of the mortgage amount. Let's use a 4 percent figure as an example. For a $90,000 mortgage, that's $3,600 (0.04 x 90,000).

Other Costs - Besides down payment and closing costs, there are other up-front costs that add up - everything from mover's fees to telephone hookup charges.

One way you can pare down your up-front costs is to pay less in points. Lenders will usually charge lower, or even no points in exchange for a slightly higher interest rate on the mortgage.

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