Q&A for Homewoners:
Q: My question for you is about how much house I can buy. I’ve changed jobs in the past year and am now earning $3,500 per month. I’ve earned this for the past 10 months but my previous two years tax returns only showed income of $12,000 per year.
How can I qualify for a $200,000 house in this situation? I have a credit score of 800 and roughly $30,000 to put down on a property.
A: Post Great Recession, it’s pretty hard to qualify for a traditional loan with only 10 months of earning history. Unfortunately, the housing crisis and its aftermath have forced lenders to become pretty strict about how much borrowers earn and what their ability to repay actually is.
If you are working for a company earning $3,500 per month, or about $42,000 per year, then you’ll have a W-2 to be able to show lenders. While you still will have trouble qualifying, you’ll qualify for a mortgage sooner — after about a year — if you work for a company than if you’re showing that as self-employment income.
(The bar is a lot higher for self-employed borrowers. Lenders will traditionally like to see two years’ worth of tax returns showing sufficient income plus a current profit and loss (P&L) statement for the business.)
The bigger issue that it’s a stretch to think you can afford to buy a home that costs $200,000 with income of only $42,000, even with a significant $30,000 down payment. Let’s walk through the numbers so you understand how lenders will think about it.
If the sales price is $200,000 and you have $30,000 to put down, you’ll need a mortgage of $170,000. Your credit history is excellent (congrats!) so you’ll get the very best interest rate, which as of today is around 4 percent or so for a 30-year fixed-rate loan. (You might be able to lower the interest rate if you’re able to pay more in points — a point is one percent of the loan amount — but that might reduce the amount of your down payment.)
Assuming you take out a $170,000 loan at 4 percent, you’ll pay $811.61 per month for the principal and interest. You can expect to pay 2 to 3 percent in real estate taxes, which is another $4,000 to $6,000 per year, or $333 to $500 per month. Add in another $2,000 for your annual homeowners’ insurance premium. Worst case: a monthly payment of around $1,450.
Conventional lenders will only allow you to borrow up to 36 percent of your gross monthly income on your total debt. At $42,000 per year, or $3,500 per month, that’s a maximum amount of $1,260 for your mortgage, taxes, insurance and any other debt you have, including student loans, credit card debt, auto loans or personal loans.
Your $170,000 loan will cost you about $200 per month more than what a conventional lender will allow you to spend on all of the debt you carry. It’s unaffordable for you. Lenders, if they’re doing their job, won’t approve your mortgage application at this time.
FHA loans, which are backed by the federal government, will allow you to spend a higher percentage of your gross monthly income, up to 41 percent or so, depending on the program. That brings you to $1,435 per month that’s available to pay all of your debt. Unfortunately, the monthly payment for a $200,000 house with a $170,000 loan, is likely to wind up higher than that.
In addition, your lender will want to know that you have additional cash reserves that you can draw on just in case something happens with your job. They like to see several months’ worth of mortgage, taxes and insurance payments safely tucked away in a bank account. If your $30,000 represents every available cent you have, that won’t fly with most lenders.
So, what is affordable for you? With interest rates at around 4 percent for a 30-year loan you might want to triple your gross income and look for a home that’s about $150,000. If you put 20 percent down (that’s the $30,000 you have on hand), you’ll avoid private mortgage insurance (PMI) which is a generally expensive lender guarantee that you won’t need.
Your loan will only be $120,000, which will translate into a monthly principal and interest payment at a much more reasonable $573 per month. Since your taxes and insurance will also be lower, you might get away with spending less than $1,000 per month, or about 26 percent of your gross monthly income.
That will feel very comfortable for you, and enable you to make your other debt payments and spend some cash to decorate and maintain your new home.
Unfortunately, shy of winning the lottery, getting a big raise, buying the home with someone else who earns income or saving a lot of money very quickly, we can’t see how you can to afford a $200,000 house in the near future.