The Federal Housing Administration provides the following guidelines for the loans that they accept:
- The front-end debt-to-income ratio – mortgage payment (Principle + Interest + Tax + Insurance) divided by gross income – should be less than 31%.
- The back-end debt-to-income ratio – mortgage payment (PITI) plus all recurring monthly debt, all divided by gross income – should be less than 43%.
To run through the number quickly to find out how much you can afford --
So assuming you have 20% downpayment and low to none recurring debt, you can afford about 5X of your annual gross income (before income tax). If you have less than 10% downpayment and some debt (up to the back-end ratio of 43%), you will probably only afford 3X of your annual gross income, considering you will also have to pay mortgage insurance of up to 1.25% of loan amount.
But keep in mind the numbers above are "quick run through" - to be a serious buyer, you need to consider other factors in life --
If you are buying a house with someone else (spouse, parent, adult child, partner/companion, brother or sister or other relative), you should consider your co-purchaser's earnings and existing debts as well. Remember, if you apply for a loan with somebody else, you and your coborrower are both legally responsible for repayment of the mortgage.
Your buying power depends on how much you have available for the down payment and how much a financial institution will agree to lend you.
Your down payment
If you are a first-time CA home buyer, the price you can afford to pay for a house may well be limited by your ability to come up with the required down payment and closing costs. If you haven't accumulated much savings, you may want to set aside funds for a down payment on a regular basis from your paycheck. Monies in your checking and savings accounts, mutual funds, stocks and bonds, the cash value of your life insurance policy, and gifts from parents or other relatives may all be suitable sources for a down payment.
Private Mortgage Insurance
Depending on the lender and loan type, you may be able to get a mortgage with as little as 3 percent or 5 percent down. However, putting less than 20 percent down often means you will be required to purchase private mortgage insurance. Private Mortgage Insurance (PMI) in CA helps protect the lending institution in case you fail to make payments on your mortgage.
Your closing costs
In addition to the down payment, you will also need to consider closing costs. The closing is the final step during which ownership of the house is transferred to you. The purpose of the closing is to make sure the property is ready and able to be transferred from the seller to you.
Closing costs generally range from 3 percent to 6 percent of the amount of the loan. So, if you were to buy a $100,000 house with a 5 percent ($5,000) down payment, you could expect to pay between $2,850 and $5,700 on your $95,000 mortgage. Sometimes, you can negotiate with the seller of a property to pay some of your closing costs, which will reduce the amount of money you will need to bring to closing.
How much a financial institution will lend you
Apart from having available funds for a down payment and closing costs, the other major factor limiting how expensive a house you can buy will be how much you can borrow.
When you apply for a mortgage, the lender will consider both your earnings and your existing debts in determining the size of your loan. Lenders generally use the FHA's 31%/43% guideline I mentioned above to determine what size mortgage you are eligible for. This is called the total Debt-to-Income Ratio.
Some lenders may have other somehow flexible guidelines for non-conforming loans; however it may means you will pay a much higher interest rate to cover their risks.
Don’t Despair, There is a Loan For You
When you go to apply for a mortgage, the lender will use all the relevant data -- your income, your existing debts, the purchase price of the house, your down payment, the interest rate on the loan, and the cost of property taxes and insurance -- and calculate whether you qualify to borrow the amount of money you need to buy the house. Shop around and you may find one that's suitable for you.
Use Affordability Calculator