Knowing up front how much home you can afford can save you time and heartache during your next home search. Lenders use a few rules of thumb to guide this process and to assess your borrowing power. By factoring in your income, debt, credit history, and down payment, we have a much better idea of your ideal price range.

Let’s start by taking a look at your debt-to-income ratios, which tells us how much you owe relative to how much you make. There are two ratios that lenders look at to assess credit worthiness: the front-end ratio and the back-end ratio.

The front-end ratio shows how much of your gross monthly income is spent on housing. The housing payment includes principle, interest, taxes and insurance (PITI). Conventional underwriting guidelines have set the upper housing limit to no more than 28% of total income. For example, if you made $50,000 per year you would be able to spend 28% of that on housing, which is $14,000 annually, or $1,166 per month.

The back-end ratio shows how much of your gross monthly income is spent covering all debt. This ratio is larger and includes everything from credit card payments to alimony to student loans, and includes your housing payment. Lenders typically limit this back-end ratio to no more than 36% of your gross monthly income. Under this guideline, a borrower who earns $50,000 per year would be able to spend a maximum of $1,500 per month on total debt.

These guidelines may be applied differently in different situations. Loans guaranteed by the Federal Housing Administration allow buyers to carry slightly higher debt-to-income ratios of 29% for the front-end ratio, and up to 41% for back-end ratio. Furthermore, if you live in an area where housing is scarce and prices are higher, there may be some discretion when applying these ratios, depending on the type of loan you seek.

Your total borrowing power is also heavily influenced by your credit and payment history, as detailed in your credit report. A good credit history is rewarded with a lower interest rate, which means lower monthly payments for the borrower. It is worth noting that an excellent credit report is potentially worth thousands of extra dollars in equivalent borrowing power when compared to those with a few blemishes!

By including your monthly housing and debt payments, and factoring in some credit assumptions and down payment, we can apply some general spending recommendations to get you started. With just a few minutes of your input, we can even offer you a pre-qualification letter or pre-approval letter to help you get off on the right foot. Please contact us for a hassle-free consultation – we are here to help!