California home loans

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How Much Home Can You Afford!

While the value of the property you buy plays a part in determining how much you can borrow, the bulk of the lender's analysis is based on you as a potential customer.  This analysis is based on three main categories:

Capacity - (income, debts, housing expenses)

Collateral - (appraisal, down payment)

Credit - (payment history)

Capacity is the real estate industry's way of understanding the financial resources you have available for buying a house.

To determine your borrowing capacity, the lender measures your total income, subtracts your debts and housing expense. They then use these numbers to create ratios (called Front and Back ratios) to rate your finances and decide what mortgages you qualify for.

You may believe you can live on Ramen noodles, walk to work and give up cable TV in order to cover that huge mortgage payment, but the lender wants to be sure you are not overextending yourself and running the risk of foreclosure.



1- Total Income

Any income that is consistent can be used to help you qualify for a loan if it can be verified. If you are a financially-aware consumer, with low consumer debt and stable spending habits, income is probably the most important factor determining your borrowing potential.

Ongoing employment

Ideally, from the banker's perspective, you should have five years of continuous employment in the same field, with at least two years at your current employer. But this is an ideal. Recently employed people can still get a mortgage.


Incremental income

Dependable income is the key to mortgage nirvana, and just about anything counts. Part-time salary, commissions, disability payments, alimony and child support, even seasonal income that can be proven for two years running is beneficial as long as it is likely to continue for the next five years or so.


If your income history is best described as "erratic," some lenders offer programs, but be prepared to pay more as a premium for the risk of lending you money.


2- Debts


For home buying purposes, your debts are defined as:

  • Credit cards

  • Home equity loans, debt consolidation loans, education and vehicle loans
  • Insurance payment liabilities
  • Legal judgments like alimony and child support

It is hard to overemphasize the importance of reducing your consumer debt before applying for a mortgage. Lenders will often reject a loan application from even a high-income borrower if he or she has a lot of consumer debt.

If you have the cash in an account or investment that pays less interest than you are being charged for your loans, and this is usually the case, you should withdraw the money and use it to pay off your debts.

But again, you should consider the interest rate consequences. Mortgages generally have interest rates under 10%, and the US government rewards housing debt by allowing you to deduct your property taxes, and home mortgage interest payments (up to $1 million borrowed) from your annual federal income taxes.

This means that your mortgage is usually cheaper than your credit cards, and if you are funding the down payment yourself, you will do better to pay off the consumer debt than to try for a larger down payment.


 2- Housing expense

Housing expense is the third calculation used to determine your capacity because the lender wants to make sure that the mortgage payments fall within a reasonable range for your income and debt level.

Over the years, lenders have seen patterns in buyers' income, debt and spending levels and watched which loans ended up in foreclosure. This led them to develop guidelines for what people can generally afford to spend each month on their monthly mortgage principal and interest payment, taxes, and home owner's insurance premium.


A high down payment may balance out high consumer debt.



Another aspect of the home purchase that is important to lenders is the collateral pledged for the loan. There are two monetary measurements: the amount of the down payment and the independent appraisal of the property's value.


In the event of foreclosure, the buyer forfeits both, and the lender expects the combined amounts to at least cover the loan. This expectation leads to an assessment of risk, called the loan-to-value (LTV) ratio. For example, a 10% down payment requires a 90% loan, and therefore has a 90% LTV ratio.


1- Appraisal


An appraisal is a professional estimate of a property's market value. The lender will have the property evaluated by an independent, licensed appraiser (though you pay for it, usually between $300 and $1,000) to make sure it is appropriate collateral for the loan. If the property doesn't appraise for at least the value of the selling price, the lender won't give you a mortgage based on that amount
2- Down payment


A down payment is that big pile of cash you personally pay to the seller.  It's the part of the purchase price not covered by the lender.


If you put down less than 20%, you'll have to pay a monthly premium for private mortgage insurance (PMI or MI). Unlike other kinds of housing-oriented insurance, PMI protects the lender when the borrower defaults, which is why they're willing to lend with less than a 20% down payment - their extra risk is covered.

There are also other ways to get help besides private mortgage insurance. Several government programs help buyers afford houses.

In the case of FHA and VA loans, local lenders offer the mortgages according to government guidelines, and the loans are then guaranteed by the government in the case of default.


These are valuable programs for people with limited funds, but they have restrictions on the amount that can be borrowed that can make them unworkable for high cost urban areas.


Another option is to find a way to share the down payment cost with someone else - either a loan from the seller, or another bank. So you could do a deal called an 80-10-10 - 80% mortgage, 10% down payment, 10% additional loan.




The credit aspect of the lending decision concerns your history as a consumer. As the lender is considering giving you a large sum of money, it's logical that they'd like to know whether you have a pattern of paying loans back promptly.



Credit Reports and Payment history


Credit reports


There are three main credit reporting agencies in the US: Experian, Equifax and TransUnion. It is generally a good idea to periodically check your credit reports to make sure they accurately reflect your spending.

What you receive will generally be an abridged version - if you discover multiple problems, you should get the full report and work through all the codes to ferret out the cause.

Credit repair
There are also credit repair agencies that specialize in helping you resolve credit problems. They charge a fee, but if someone stole your wallet and has been using your social security and credit account information on a wild spree, it may be worth it to get professional help.

Credit disputes
It can take several weeks or even months to resolve credit disputes so the earlier you know you have problems and start trying to clear them up, the better.

Traditional mortgage wisdom says that you need good scores in two of these three if you want to get a mortgage. Balance is key - a big down payment combined with steady income can compensate for a less-than-stellar credit rating.