Used-car salesman make money by selling cars, barbers make money by cutting hair, and mortgage brokers make money by getting you to borrow. There isn't any reason to believe that any one has your interests at heart.
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Mortgage brokers get paid when you get a loan, frequently on a variable commission. They have every incentive to make the process as painless as possible, but they also have an incentive to get you to borrow as much as possible.
How much can you really afford?
Spend too much time on the internet and you'll find pages of puzzled future homeowners asking questions for social-media-savvy mortgage brokers to answer. It always goes the same way. The soon-to-be homebuyer asks how much they can borrow, and several brokers post public replies, suggesting that "it's complicated," or that there are programs for every situation. Most replies end with some version of "call me."
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There really is an easier answer. The standard underwriting criteria for conventional mortgages has always been based on "28/36" ratios. It's a pretty good rule of thumb.
Under this standard guideline, your monthly principal, interest, property taxes, and interest payments on your mortgage (PITI for short) should be less than 28% of your pre-tax income. This is called the "front-end ratio." If you make $5,000 per month before taxes, your direct housing costs should be less than $1,400.
The second part, called the "back-end ratio," adds other monthly loan payments (and child support) that you will have for at least 10 more months to your PITI costs and divides that total by your monthly pre-tax income. If you make $5,000 per month, your PITI plus recurring debt payments (student loans, car loans, child support, etc.) should be less than $1,800 per month.
If your front-end ratio is under 28% and your back end ratio is under 36%, you should be good to go. You really can afford that home you wanted to buy.
It's so easy to stretch
The only problem with basic ratios is that many people aren't satisfied with how little they can borrow, and it's all too easy -- often encouraged -- to borrow more. Programs for first-time homebuyers through the Federal Housing Administration (FHA) start with ratios of 31/43, which gives borrowers 3 percentage points of breathing room on the front end and 7 percentage points on the back end.
That's just the start of looser lending, though. If the home is energy efficient, you can qualify with ratios as high as 33/45. Borrowers with credit scores of 580 or higher -- 620 or lower is subprime -- can qualify at 37/47 under less-than-stringent criteria. The FHA even allows for ratios as high as 40/50, provided you can meet some fairly lenient income requirements.
Of course, if the loan is outside the scope of a government program, the sky is really the limit. Accepting a higher ratio simply requires a signature -- whereas paying down a car loan for some extra room on your back-end ratio will take some sacrifice.
Ultimately, the difference between a 25% front-end ratio and a 40% front-end ratio may be the difference between living comfortably or living paycheck to paycheck. For your mortgage broker, it may be the difference between an average payday and one that's 60% larger.
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