Home Buying Kit For Dummies. Eric Tyson

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      © John Wiley & Sons, Inc.

      FIGURE 3-1: It takes many years into a mortgage to begin making real progress at repaying the amount originally borrowed. In this case, paying off half the loan balance takes nearly 22 years.

For a given property that you’re considering buying, a mortgage lender calculates the housing expense and normally requires that it not exceed a certain percentage (typically around 40 percent or so) of your monthly before-tax (gross) income. (Some lenders allow the percentage to go a bit higher.) So, for example, if your monthly gross income is $6,000, your lender will not allow your expected monthly housing expense to exceed $2,400 (if the lender is using 40 percent). When you’re self-employed and complete IRS Form 1040, Schedule C, mortgage lenders use your after-tax expenses (net) income, from the bottom line of Schedule C.

      About the only other financial considerations a lender takes into account (besides your income) are your other debts. Specifically, mortgage lenders examine the required monthly payments for student loans, an auto loan, credit-card bills, and other debts. In addition to the percentage of your income lenders allow for housing expenses, lenders typically allow an additional 5 percent of your monthly income to go toward other debt repayments. Thus, your monthly housing expense and monthly repayment of nonhousing debts can total up to, but generally be no more than, 45 percent.

      STRETCHING MORE THAN LENDERS ALLOW

      Sometimes, prospective home buyers feel that they can handle more debt than lenders will allow. Such home buyers may seek to borrow more money from family or fib on their mortgage application about their income. (Self-employed people have the greatest opportunity to do this.) Such behavior isn’t unlike the shenanigans of some teenagers who drive above the speed limit, drink and smoke forbidden things, or stay out past curfew and sneak in the back door.

      Although a few of these teenagers get away with such risky behavior, others end up in trouble academically or psychologically (or worse). The same is true of homeowners who stretch themselves financially thin to buy a more costly property. Some survive just fine, but others end up in financial, legal, and emotional trouble.

      And, increasingly, home buyers who lie on their mortgage applications are getting caught. How? When you’re ready to close on your loan, lenders can (and often do) ask you to sign a form authorizing them to request a copy of your income tax return from the IRS. This allows the lender to validate your income. (See Chapter 7 for more details.)

      So although we say that the lender’s word isn’t the gospel as to how much home you can truly afford, we will go on record as saying that telling the truth on your mortgage application is the only way to go (and prevents you from committing perjury and fraud). Telling the truth is not only honest but also helps keep you from getting in over your head financially. Bankers don’t want you to default on your loan, and you shouldn’t want to take the risk of doing so either.

      Figuring the size of your mortgage payments

      Calculating the size of your mortgage payment, after you know the amount you want to borrow, is simple. The hard part for most people is determining how much they can afford to borrow. If you already know how large a monthly mortgage payment you can afford, terrific! Go to the head of the class. Suppose you work through your budget in Chapter 2 and calculate that you can afford to spend $1,500 per month on housing. Determining the exact amount of mortgage that allows you to stay within this boundary is a little challenging, because the housing cost you figure that you can afford ($1,500, in our example) is made up of several components. Lucky for you, we cover each of these components in this chapter, including mortgage payments, property taxes, insurance, and maintenance. (Note that although lenders don’t care about maintenance expenses in figuring what you can afford to buy, you shouldn’t overlook this significant expense.)

      As you change the amount that you’re willing to spend on a home, the size of the mortgage you choose to take out also usually changes, but so do the other property cost components. So you may have to play with the numbers a bit to get them to work out just right. You may pick a certain home and then figure the property taxes, insurance, maintenance, and the like. When you tally everything up, you may find that the total comes in above or below your desired target ($1,500, in our example). Obviously, if you come out a little high, you need to cut back a bit and choose a slightly less-costly property and/or get a smaller mortgage.

Using Table 3-1, you can calculate the size of your mortgage payments based on the amount you want to borrow, the loan’s interest rate, and the length (in years) the mortgage payments last. To determine the monthly payment on a mortgage, simply multiply the relevant number from Table 3-1 by the size of your mortgage expressed in (divided by) thousands of dollars. For example, if you take out a $150,000, 30-year mortgage at 5.50 percent, multiply 150 by 5.68 (from Table 3-1) to arrive at an $852 monthly payment. (You can access Table 3-1 online at www.dummies.com/go/homebuyingkit7e.)

TABLE 3-1 Monthly Mortgage Payment Calculator