Southeast Valley Real Estate

Buyer Examples

The following examples do not indicate the interest rates one will obtain nor whether one will get approved for a particular loan amount on a given property. These are matters affected by the credit worthiness of the potential borrower (for example whether they had made their rent payments on time) and the policies of the lender. The examples are only meant to show how one already paying a certain amount of rent (for a couple of years) might be able to afford the purchase of a property. They also are designed to show how today's relatively low interest rate makes a given property more affordable than they were when a higher rate was prevalent a few years ago.

First of all, FHA's maximum housing ratio is 29%, meaning that the PITI payment may not exceed 29% of borrower's gross income. The total debt ratio is 41%, meaning tht all debts and recurring monthly charges, including PITI housing payment, may not exceed 41% of borrower's gross income. These are known as 29/41 ratios.

Example 1

Assume that a couple (or individual) has been leasing a 2-bedroom apartment for the past two years at $700.00 month not including utilities (they have not been late on rent payments). Their gross (before taxes) household income is $2600 per month or $31200 per year. The monthly payments on long term debt (extending more than 6 months) is $120 per month. Savings amount to $6500. The couple has seen a 2-bedroom town house, which is listed at $98,000, but they feel they probably can get it for $95,000. The estimates for property expenses are:

If the couple can get an interest rate of 6.5% (1% origination and no points) and make a 5% down payment in the amount of $4900, can they afford a FHA loan in the amount of $93,100? Since the couple thinks that they can get the townhouse for $95,000 they are thinking of making an offer on the property of $98,000 in which the sellers would agree to pay $3000 of buyer's closing costs.

The lender is using FHA guidelines of 29% (PITI) and 41% of gross income. And, the potential buyer would probably qualify for the $93,100 loan.

There are many benefits to home ownership over renting. One important one is the income tax saving that can accrue. Individual circumstances vary and one should utilize a professional tax advisor such as an accountant but, for our example, we will assume that our couple is paying an incremental income tax rate of 15% on their federal taxes and 2.87% on their state taxes for a combined rate of 17.87%. During the first year of their mortgage based upon our example the mortgage interest and property taxes would generate a savings of $1215.31. Which comes out to $101.28 per month. These savings would effectively lower the monthly after tax cost from $857.59 to $756.32. In other words, the monthly mortgage payments would still be $857.59 but a tax savings would occur which could be realized either in a larger refund when ones tax return was filed or through smaller withholding through the year or some combination of the two.

For comparison sake, let's assume that instead of the 6.5% interest rate that the available interest rate was 8.5%.

Using the same guidelines the bank would probably not approve the loan for $93,100 at the higher interest rate. It which case, the borrower would have to come up with a larger down payment, pay-off more long term debit, settle for a less expensive property, or perform some combination of these options.

Example 2

Assume that an individual has been leasing a 1600 square foot 4 bedroom home for $1250 per month for the past three years. Her gross income is $4550 per month or $54,600 per year. Her total monthly payment on long term debit is $250 per month. Savings amount to $24,000. The owner has offered to sell the house to her for $160,000, which is below appraisal. The owner has indicated that if the tenant does not buy the house that he intends to sell it in the spring after the lease ends. The estimates for property expenses are:

If the tenant can get an interest rate of 6.5% (1% origination and no points) and make a 10% down payment in the amount of $16,000, can she afford a 30 year conventional loan in the amount of $144,000?

The lender is using conventional financing guidelines of 28% and 36% of gross income. And, the potential buyer would probably qualify for the $144,000 loan.

There are many benefits to home ownership over renting. One important one is the income tax saving that can accrue. Individual circumstances vary and one should utilize a professional tax advisor such as and accountant but, for our example, we will assume that our individual is paying an incremental income tax rate of 27% on their federal taxes and 3.2% on their state taxes for a combined rate of 30.2%. During the first year of their mortgage based upon our example the mortgage interest and property taxes would generate a savings of $3235.21. Which comes out to $269.60 per month. These savings would effectively lower the monthly after tax cost from $1387.34 to $837.74. In other words, the monthly mortgage payments would still be $1387.34 but a tax savings would occur which could be realized either in a larger refund when ones tax return was filed or through smaller withholding through the year or some combination of the two.

In this example, as it turned out the after tax cost of ownership (effective cost) came out to be lower that the cost of renting. Renting at $1250 and after tax ownership cost at $837.74. When combined with the possible appreciation in value of the property over the years and favorable capital gains tax treatment for home owners one can see why there can be real financial advantages to home ownership. Individual circumstances will vary so have you tax advisor review your particular situation.

Again, for comparison sake, lets assume the available interest rate were 8.5%.

Using the same guidelines the bank would probably not approve a conventional loan for $93,100 at the higher interest rate. It which case, the borrower would have to come up with a larger down payment, pay-off more long term debit, settle for a less expensive property, possibly use a FHA loan, or perform some combination of these options.

I can perform a similar analysis for you help you determine what price range you might be able to afford. Alternatively, I can put you in touch with a mortgage broker or loan officer that will perform a pre-qualification and provide you with documentation of your level of pre-qualification. One should be pre-qualified before search for a home. And, if a lender has all your documentation on hand he can more easily provide you with a pre-approval to submit with your offer or shortly there after.