Wheatworks Blog: Financial Matters

If you’re buying a home, the chances are great that a lender will offer you a loan for a whole lot more money than you can reasonably afford. Why? Because the lender will make money up front and pass your loan to investors.

In the past, your local banker was someone you knew. And when you borrowed money from the bank to purchase a home the banker was careful to lend you only what you could afford … even if you wanted more. This wasn’t necessarily because the banker had your best interest at heart. The local banker knew the bank would lose money if you couldn’t afford your payments and the bank foreclosed on your home.

In the last decade, the mortgage lending world changed. Mortgage brokers take their portion of a home loan and pass the mortgage to anonymous investors in mortgage-backed securities. Mortgage loans are now packaged into mortgage-backed securities in what the financial wizards thought was a way to reduce risk to investors. If you’ve paid any attention to the main stream media this year, you realize the gig is up. The real estate market is in a tailspin for home owners who need to sell. The pendulum has swung towards the buyer’s side of the equation in many areas of the country.

Against this national background of crazy lending which allowed home buyers to borrow so much more than they can safely afford, how can someone know how much money they can safely borrow to buy a home?

First, smile when a lender tells you how very much you qualify to borrow. It feels good to hear it. Second, ignore it. That’s probably crazy lending and the number may be way too high.

What you’re really interested in is not what you may be “qualified” to borrow. You really want to know what you can safely afford to borrow. And this is where you need to be very honest with yourself.

Suppose you’re married and both of you are employed. Should you use both salaries in your mortgage qualification? Only if you’re sure both of you will continue to be employed. If one of you becomes disabled or decides to stay home with children, you’ve cut your income significantly. When it happens, you’ll be happy if you qualified for a mortgage using only one of your incomes.

One of the 16 calculators in Real Estate Calculator Suite is the Mortgage Qualifier. It is very conservative. The Mortgage Qualifier uses loan underwriting standards that worked for borrowers before the recent period of crazy lending. The Mortgage Qualifier provides a good starting point to help you determine the maximum monthly payment and loan amount for which you qualify under safe underwriting guidelines.

What are safe underwriting guidelines? Bankers once commonly used two ratios to determine what a home buyer could afford, the housing ratio (28%) and the debt ratio (36%).

The housing ratio determined the borrowers maximum monthly housing expenditure and included the total housing payment: principal, interest, taxes, insurance, private mortgage insurance and homeowners association fees.

In addition, bankers also looked at the qualifying debt ratio which determined the borrowers maximum month debt expenditure. Lenders once knew that one’s entire monthly income cannot safely go towards the mortgage and debt payments. Home buyers must also have money left over each month for food, utilities, transportation, healthcare, savings, education, and fun!

If you want a good way to find out what you can safely afford, try the Mortgage Qualifier in Real Estate Calculator Suite. Compared to crazy lending, Real Estate Calculator Suite offers a safer, more conservative perspective on buying a home. It focuses on helping you determine how much home you can afford now and in the future.

Download a free, fully functional trial version of Real Estate Calculator Suite.