How Much Can You Afford?
Anu and Michael are young and their lives are still very much in transition. Michael is making his way through medical school -- and taking out a lot of student loans to do it. Anu is just starting her career, not making as much as she would like, and unsure how quickly her salary will grow in a slow economy.
But they're ready to move from the city to the suburbs -- a big new dog is just one factor making them feel cramped in their space -- and they'd like to buy. The problem is, they want to know how much they should rely on their earning potential in deciding how much house they can afford. And they wonder whether Michael's loans will hurt their chances for a mortgage.
Anu and Michael, along with other young potential homebuyers have lots of questions about how how much home they can afford, how to make the mortgage process go more smoothly and how much debt they can safely take on to get the house of their dreams. So they asked the experts during our What Works Now video discussion.
For example, Samantha, who wants to buy a home in Calais, Maine, is intimidated by how long and complicated the mortgage process is. She wonders what she can do to speed things up?
The time-consuming part of the process involves getting together all the information that a lender wants, such as: paystubs and W-2s; financial statements that show how much you've saved overall and for retirement; and paperwork on any debt you're making payments on.
Then the lender needs time to confirm and review all of it. They'll want to know "your total financial picture," including everything related to your income, savings, other assets and debt, says Todd Dal Porto, Home Loan Enterprise Sales Executive for Bank of America. "Even though it can be a little more complex for consumers, if they organize themselves properly and they seek quality advice early and often in the process, they can absolutely get though it."
Even if you're organized you can still be concerned as to what a bank will make of your financial history. Gerance, who is in his late 30s and wants to buy a condo, keeps hearing about banks tightening their lending standards and wonders how that might change the loan process for him, or affect how much he can borrow.
Dal Porto explains that among other things, banks look at two key items: The ratio of the loan to the value of the home (that is, do you want to borrow, say 80 percent or 90 percent of the purchase price); and the minimum credit score needed for that particular ratio. He adds that banks are looking for "fuller documentation," including letters of explanation about certain financial events in your history, which can make the loan process seem more restrictive.
Another factor banks consider is a potential borrower's debt-to-income ratio. Michael and Anu would like to know what that is, and how they can know whether they have enough money now to buy a home for the long term.
That all-important debt-to-income ratio is the amount of a borrower's total debt expressed as a percentage of your total monthly income. It includes a mortgage (plus property taxes and insurance), student loans, car payments and credit card debt. So if the house payments alone amount to 30 percent of your income then your house payment plus other debt will be somewhat more.
Khalfani-Cox advises would-be house buyers like Anu and Michael to try to "knock out" some of their debt, especially credit card debt, before applying for a mortgage to improve that important ratio.
While young couples tend to look for homes they can grow into, Khalfani-Cox advises against stretching how much you can afford to borrow, on the assumption that your household income will go up a given amount every year. Instead, she says, consider what-if scenarios that might cause a couple to lose one or both incomes, such as unemployment.
Dal Porto adds that future earning potential isn't a factor that bank's consider in loan applications. "Just the current income and the history," he says.
Anu and Michael, and other young buyers would be prudent to do the same.
Interested in learning more about buying a home? Here are some AOL Real Estate guides that might help:
Want to learn more about home buying and home finance? If so, you won't want to miss
our online discussion with industry experts,
"What Works Now: Smart Moves When Buying a Home,"
created by AOL Real Estate in participation with Bank of America Home Loans.
Watch it now on AOL Real Estate.