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"How much house can I afford?"
That's the question of the year for home buyers who have begun to realize that with today's new rules of mortgage finance, affordability rests a great deal on factors other than annual income.
Sure, how much money you earn each year is an important part of answering the affordability question. If you don't have verifiable income, your mortgage loan application won't be approved.
But other factors play into the affordability question as well -- starting with your credit history and credit score.
If you have a lower credit score, the interest rate on the loan you eventually secure will be higher, and the answer to the "How much house can I afford" question will be "Less."
Most lenders will require you to have a credit score between 620 and 660 if you want to qualify for an FHA loan. If you want to get a conventional loan, you'll need a credit score above 680, and preferably over 720.
Another crucial factor is how much cash you have on hand for closing costs and a down payment. Not only will you get a better interest rate if you have more cash to put down on the property, but if you have at least 20 percent to put down on your house purchase, you'll also avoid paying private mortgage insurance (PMI).
Paying PMI is expensive, and a lender will subtract the amount of the insurance premium from the income that's available to make your mortgage payment.
If you're buying a condominium, co-op, townhouse or a single-family house in a community that has a homeowner's association, the monthly fee you're assessed will be deducted from the total amount you have available to make your mortgage payment.
Other monthly, recurring costs will also be deducted from the amount a lender believes you have to pay your mortgage. For example, if you carry a balance on your credit cards, and have for a long time, the monthly "debt service" you pay to the credit card company reduces the funds you have available to pay your monthly mortgage.
Lenders will also subtract your monthly debt service on student loans, car loans and any other monthly debt payments you make -- all of which could leave you with precious little to make those monthly mortgage payments.
For those home buyers who own their own businesses, how much income you declare on your tax return will be the driving factor behind how much house a lender believes you can afford.
The days of qualifying for your mortgage based on cash flow in the business, rather than on income you declared on your taxes, is over for the moment. Stated income loans (where you tell the lender how much money you earn or claim to have earned) have virtually disappeared.
Mortgage lenders want to see at least two years' of tax returns for your business as well as a profit and loss statement for the current year, among a myriad of other documents.
Home buyers who depreciate investment property on their tax returns to the extent it reduces income down to perhaps nothing, may find it even more difficult to qualify for a mortgage.
It all comes down to the new rules of mortgage finance.
Finally, don't just accept what lender says that you can afford on a home. Make sure that you feel comfortable with that amount and can live comfortably with the future monthly payments for the loan as they come due.