Getting a mortgage can be a time consuming and confusing process. One of the best ways to deal with it is to break down the entire process into several different steps. This will help keep you from getting overwhelmed and also from missing an important phase.

One of the first things you should do when considering buying a house and deciding to get a mortgage is to determine just how much house you can afford. This is typically a function of two things: how much you can borrow from a bank or credit union versus how much money you can afford to put down. It will also depend a great deal on how much money you make. While there is no magic number for the perfect home or getting the perfect mortgage, you typically don’t want to spend more than 25% of your take home pay on a house note every month. In order to determine how much you can spend, take some time to insert your monthly income, expenses, term of loan, down payment and interest rate into an online mortgage calculator.

Next, you will want to determine what type of mortgage you want. If you can, determine if you can afford to take out a fifteen year mortgage rather than a thirty year one. This will not only save you thousands of dollars in interest, but you’ll own the house much sooner.

Before applying for a mortgage, you will also want to shop for one. Many people still choose to go to their local bank and apply for one there. This is especially true when you might get a small discount in interest rates if you already have accounts at that particular bank. However, a more and more popular option is to look for a mortgage broker. These brokers act as a go between for you and lending organizations. They take care of all the paper work and help find you the best deal possible by shopping your mortgage application to numerous different lenders. Do keep in mind, however, that they will charge a percentage of the loan for their services.

Next, get your finances in order and determine how much money you can afford to put down on your new house. While no money down loans are almost a thing of the past, you can still find loans and get mortgages with down payments of as little as 3.5-4%. However, you ideally want to be able to put down 10-20%. This will not only make you more attractive to a lending institution, but will save you money and interest. In addition, you will want to get a copy of your credit report. Those with a FICO score of at least 730 will get the best rate. For FHA loans, you will need a score of at least 690. Finally, try to be debt free and have at least six months of savings in the bank in addition to the money you have earmarked for the down payment.

If you follow the above the tips, you will make the entire mortgage process much easier and increase your chances of being approved with an acceptable interest rate.

What is a Debt-to-Income Ratio?

A debt-to-income ratio represents a percentage of your income that goes toward paying debts.  Think of it as a snapshot of your spending habits.  Calculating your debt-to-income ratio is very easy.  Take a look:

• Monthly Income =  $4,000
• Monthly Debt = $1,000
• Divide $1,000 by $4,000 to get .25
• Your debt-to-income ratio = 25%

What is Included in your Income Number

Let us look in a bit more detail, how we calculated the monthly income number in the above example.

Your debt-to-income ratio is best figured on a monthly basis.  Your biggest source of income will most likely be your salary.  Debt-to-income ratios are based on gross income (that is before taxes and insurance are taken out of your paycheck). To quickly calculate your monthly gross salary, do so with one of two calculations:

• Take your yearly income and divide by 12
• If you get paid biweekly (every other week), take one pay check’s gross pay and multiply it by 2.17

In addition to your monthly paycheck, include:

• Regular income from alimony and child support
• Averages of bonuses, commissions and tips
• Dividends and interest earnings
• Government benefits and assistance
• Income from a side business
• Other miscellaneous income

What is Included in Your Debt Number

Let us take a look at what is included in your monthly debt number:

• Rent or mortgage payment (including property taxes, insurance, private mortgage insurance and association fees)
• Car payment
• Minimum credit card payments (only minimum due; not balances)
• Student loan payment
• Child support and alimony
• Legal judgments
• Other monthly debt obligations

What is Not Included in Your Debt Numbers

• Food bills
• Entertainment expenses
• Utilities
• Clothing
• Informal personal loans

The Results – How to Interpret Your Number

Once you have calculated your debt-to-income ratio, refer to the following to view that snapshot of your spending habits and financial stability:

• 35% or less: a healthy debt load to carry for most people
• 36% – 42%: pay closer attention to your debt before problems arise
• 43% – 49%: take immediate action as financial difficulties may be imminent
• 50% or more: get professional help to aggressively reduce debt

How Mortgage Lenders Use Debt-to-Income Ratios

Mortgage lenders approach the debt-to-income calculation from the other direction.  They strive to offer loans that will keep their customers within a specified debt-to-income ratio range.  Your lender will use two different ratios to analyze your situation; one factors in only your new housing expense and the other uses your existing recurring debt plus your new housing expense.

The first type of ratio is what is known as a front-end ratio.  This is the percentage allowed for housing expenses only.  For conventional loans (we’ll see the limits for other loan types later) the front-end ratio limit is 28%.

From our example above:

• Your monthly income is $4,000
• $4,000 times 28% = $1,120
• The maximum loan the lender should offer is one that converts to $1,120 per month in HOUSING ONLY debt.

So far, your lender has calculated a mortgage payment based on your income and housing debt.  He will now turn his focus toward your other recurring debt.  This can be a game changer.  Your lender wants to make sure you can pay for your new loan and still pay for everything else.  He will calculate what is called your back-end ratio. The back-end ratio is a percentage allowed for housing expense plus your other recurring debt.  In our conventional loan example, a back-end ratio limit is 36%.

• Your monthly income is $4,000
• $4,000 times 36% = $1,440
• The maximum loan the lender should offer is one that converts to $1,440 per month in TOTAL debt.
• If the difference between the back-end and front-end amounts ($1,440 – $1,120) does not cover your other debts, the lender will need to lower the amount he can offer you.

Ratio Limits by Mortgage Type

The front-end and back-end ratio limits differ depending upon the mortgage type.  Conventional loans are defined as any loan that is not backed by the federal government.

• Conventional loans:  front-end ratio of 28 and back-end ratio of 36
• FHA loans: 31 and 43
• VA loans:: 41 and 41
• Jumbo, non-conforming loans: 45 and 55

The Way the Ratios are Written (and are Mistakenly Read)

In this article I have written the ratios as “28 and 36”.  You will see however, the ratio is more commonly expressed as 28/36.  This can be misleading.  These numbers represent the front-end ratio and a back-end ratio.  We are not looking at a fraction or dividing one number into the other. Though because we are talking about ratios, that could be anybody’s first impression.

Other Tips

• Try running your numbers based on net income (after taxes and insurance) to get a better picture of your situation
• Include all of your monthly expenses in your calculation (remember, the lender will only include formal, recurring debt)
• Run your own ratio before you meet with your lender.  Read our article about being a responsible home buyer to see why.

How Much You Can Borrow is Different from How Much You Can Afford

A mortgage lender will use a standard calculation to determine how much he is willing to lend you.  He will gather from your application, information about your income, debts, credit, and available down payment.  By calculating what is called a debt-to-income ratio, your lender will determine how much he can safely (an extremely subjective term) lend you.

However, you must know the following about the lender’s calculation:

• Only recurring debt is included, such as home equity loans, car payments, minimum credit card payments, student loans, furniture store loans, alimony, child support, etc.
• Other miscellaneous debts and obligations such as informal personal loans are not included
• Other household and living expenses are not considered
• Expenses associated with your personal life style are not considered
• Future financial demands and plans with regards to career and family are not considered
• The ratio is based on your gross income, not after-tax income

As you can see, with the many debts and obligations that are excluded in the lender’s calculation, the amount of money he can offer will most likely be higher than you would have thought it to be.  This is where the trouble begins for many home buyers.

Awaken the Responsible Home Buyer Within

By the nature of the many debts and obligations excluded from the debt-to-income ratio;  it should be obvious that the lender’s number simply isn’t going to work for you.  This is where personal responsibility comes into play.  Do not ignore the discrepancy between the lender’s numbers and what you can truly afford.  And don’t be discouraged.  This is your reality; embrace it and adjust.  Look a little harder for a suitable home that fits your budget or perhaps rent until you remove other debts or save for a larger down payment.  Do whatever it takes to avoid becoming house poor or worse yet, foreclosing on your new home.

When to Do Your Own Calculations

You can see the importance of running your own numbers before you talk with a lender.  Walk into a lender’s office telling them what you can afford and what you are comfortable paying.  It is so easy to become “wowed” by your overinflated buying power.  As they say “don’t even go there!”

Pre-Qualified

The process of getting pre-qualified for a home loan is quite easy.  You can do so in person at a local bank or mortgage lender or better yet, on the phone or via the internet.  The service is usually free of charge.  The lender will ask you for very basic personal and financial information.  Be prepared to provide your:

• address and how long you have lived there
• total income
• total debts
• current assets
• overview of your credit standing

The lender will use this information to estimate what you will likely be able to borrow.  This is an “educated guess” and is simply used to ballpark the price range for your new home.

While this information is very important to you in terms of budgeting for your home, it may or may not impress the seller if you are hoping to use it as bargaining tool.  The sellers are aware that the mortgage lender is not committed to providing you a home loan as a result of running these numbers for you.  The seller will want more.

Additionally, because the lender did not verify your accounts or debts and in most cases did not pull your credit report, the pre-qualification letter will be chock full of disclaimers.  The pre-qualification statement will be subject to:

• a formal mortgage application
• verification of employment
• verification of assets
• overview of debts
• credit rating and score
• additional underwriting guidelines

Pre-Approved

A mortgage pre-approval takes the pre-qualification process a few steps further.  A pre-approval will impress a seller and will give you even more confidence regarding your home buying budget.  And as a bonus, getting financing out of the way will let you focus on picking the right home in the right neighborhood (the fun part of home buying).

A pre-approval requires a formal application process.  Be prepared to provide:

• pay stubs for last 30 days
• two years tax returns and W-2’s or business tax returns
• proof of other income
• proof of other assets (stocks, pension funds)
• three months of bank records for all accounts
• source of your down payment
• contact information for employers for the last 2 years
• contact information for landlords for the last 2 years
• current debt information: account numbers, payment amounts, balances, etc.

Upon approval you will receive a formal pre-approval letter.  This will be a written commitment from your lender which your sellers will be thrilled to see.  Be aware however, it is not free of conditions, yet.

When the lender pre-approved you, it was only for the amount of money which you can afford for the purchase of your home.  Remember, you have not yet found that home.  When you do, the lender will insist on an appraisal of the property so they can be sure they are not lending you more money than the house is worth.

Additionally, if there is a significant amount of time between your pre-approval and when you find your home, the lender will want to make sure there are no changes in your employment status, financial situation, or credit worthiness.  When you are ready to close on the loan, the lender will re-verify your information.

Your mortgage loan will be fully approved when the appraisal is complete, the title search is done, your information is re-verified and a credit-check is re-run.

From the resource: “How much house can I afford? This depends on your down payment and your income. Bankers use a somewhat flexible formula, including payments and debts, to determine how much house you can afford. You can use that formula, too. It’s called the 28/36 Ratio (28% is called the Housing Ratio, 36% is called the Debt Ratio-See below for full explanation).”

Source: Consumer Credit Repair

Read More About Home Affordability at Newbuyer.com

The introduction to the resource: “How much you can borrow to buy a home is a factor of how big of a monthly payment you can afford. Your monthly payment is made up of the amount you are borrowing and the interest the lender charges you.”

Source: GetSmart

Read More About Mortgage Affordability at Newbuyer.com

From the resource: “Different lenders have different application procedures, so it will vary slightly from one mortgage lender to the next. With that being said, most lenders will check your credit score as early on in the application process as possible.”

Source: Consumer Credit Help

Read More About Mortgage and Your Credit at Newbuyer.com