No Money for a Mortgage Payment

Having no money could mean one of two things. 1) You have don’t have money for a down payment and/or closing cost or 2) you are not making enough to qualify for a house or make your mortgage payment. This article is about the second issue. If you need help coming up with a down payment and closing costs, read about some helpful options here. Before we go into how much money you need to qualify for a house, let’s discuss debt to income ratios (DTI). This post will contain a lot of math!

Debit to Income Ratios (DTI)

It’s easiest to get approved for a loan when your DTI falls within the range of 28%/36% which is your front end and back-end DTI respectively. The front end DTI  includes all the cost associated with the house itself; the principal, interest, property taxes and insurance (PITI). This  cannot exceed 28% of your monthly income. The back-end DTI includes all cost associated with the house, the 28% and all other monthly obligations. This cannot exceed 36% of your monthly income.

If you have no other debt that does not necessarily mean the mortgage payment can amount to the entire 36% of your monthly income. Technically, the mortgage payment must still only come to 28% of your monthly income.

For the purposes of this article, we are going to use the 28%/36% range.  However, it is important to state conventional loans will allow a DTI up to 45% – 50% and FHA will allow a DTI up to 57% in some circumstances. The programs that allow higher DTI’s have quite a bit of mitigating factors so we will stick the basics. But, your lender will be able to address the higher front end and back-end DTI programs with you if they offer them.

Monthly Obligations   

debtKeep in mind that monthly obligations will usually show up on a credit report. Court ordered child support and alimony payments might not. When filling out a mortgage application, declare any court ordered payments as a monthly obligation even if these items do not show up on your credit report. The underwriters will catch court ordered items because they search public records for these types of cases.

Monthly obligations will not include items like car insurance, utilities, or child care and so on. You know what you have pay per month – be honest with yourself when creating your budget, so you don’t over extend yourself trying to buy a house. If you need a method to keep track of your spending try using the budget spreadsheet or one of the programs located here.

Calculating Debt to Income

Debit to income is an important aspect of mortgages. It does not matter how good your credit is, you must also have sufficient income to qualify for a loan. The banks are not just looking for you to have a down payment and closing costs. You must be able to afford the mortgage on a monthly basis.

Let’s calculate DTI. There are two common methods and depending on your lender and situation, they might use one or both.

Using Paycheck Stubs to Calculate DTI

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When purchasing a house banks use pre-tax dollars to qualify you. Let’s assume you have a full-time job. You work 40 hours per week, 52 weeks per year at 7.25 per/hr. Use the formula below to calculate your yearly salary.

Yearly Salary = $7.25 * 40 * 52 = $15,080.

The banks work off of a typical 12 month year. Whatever your yearly salary is will be divided by 12. This formula will give you your pre-tax monthly income.

Monthly Income = 15,080 / 12 (months) = $1256.66.

You can calculate your front and back-end DTI using your monthly income. Remember, the front end DTI is 28% (the mortgage payment including all taxes and insurance).  The back-end DTI is 36% (all of your monthly obligations that show up on your credit report and any court ordered payments).

Front End DTI (28%) = $1256.66 * 28% = $351.86

Back End DTI (36%) = $1256.66 * 36% = $452.40

If we subtract the 28%, 351.86, from the 36%, $452.40, that will give us the amount you can have in additional monthly obligations.

Additional Monthly Obligations $452.40 – $351.86 = 100.54

What can you do with $351.86 and $452.40? Well, a lot… maybe

First, let’s keep things in perspective. You probably won’t have a $300 car note if you are making $7.25 an hour. If you do then you need to decide what’s more important. The car you drive or owning a home? If you want the nicer car – that’s perfectly understandable – we spend a lot of time driving! If you enjoy going out and spend a majority of your monthly income on entertainment – that’s great! Life is short! Buying a house might cut into your entertainment budget and while those expenses do not show up on any credit report, if you spending it could definitely affect your ability to pay your mortgage.

Being Responsible About Your Choices

responsibleLooking for homes that cost $100,000 if you are making $7.25 per/hr is not advisable – nor would be approved for such a large mortgage payment. This type of lending is what caused the mortgage crisis of 2008.

To keep price under control make sure to search for the types of homes that would fall in your price rage. Some areas have houses for $50,000, while in other areas you might be restricted to searching for townhouses. Regardless, it would still be something you own.

Because of industry regulation $50,000 dollars is usually the minimum mortgage amount banks will finance. Therefore, you will want the property to cost at least $52,000 to account for the required down payment. Let’s assume you are getting a FHA loan, you will have to put a minimum of 3.5% down.

Down Payment Amount = $52,000 * 3.5% = $1820.

Finance Amount = $52,000 – $1820 = $50,180.

Calculating a Mortgage Payment

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  1. A $50,180 financed at 4.25% interest rate comes to $252 a month. You can check this math using a mortgage calculator located here.
  1. Property insurance would be approximately $25 per month since you are only insuring the inside of the unit with a townhouse purchase.
  1. Taxes would be another $25 per month. This would also be low on such a small mortgage amount, but could also vary by county, city and state.
  1. Mortgage Insurance Premium (MIP) on a FHA loan will be approximately $36 a month on $50,180.

*** The Upfront Mortgage Insurance Premium is a second mortgage insurance premium you pay on FHA loans. This premium will either be financed throughout the loan or paid at closing. To keep the monthly payment down, try paying this at closing, especially if you are getting assistance with the closing cost. Read more about FHA mortgages here. Make sure you check other mortgage options!***

Let’s add this all up.

$252 mortgage payment

$25 property insurance

$25 property taxes

$36 mortgage insurance

==================

$338 Total Monthly Mortgage Payment

Breaking it Down

Remember, the front end DTI on a $7.25 per/hr salary is $351.86. The $338 mortgage payment meets this qualification criterion. Not too many places have rent as low as $338.00 per month.

The back-end DTI on a $7.25 per/hr salary is $452.40 – $338 (total mortgage) = $114.40 left over for monthly debt.

Note: If the mortgage payment come in less than the 28%, it’s fine if you have additional monthly obligations as long as the total of those obligations and mortgage do not exceed 36%. That $114.40 will leave money for a car payment or credit card bills.

If you are getting child support, social security, alimony or any pensions, these items can also be used to increase your monthly income. The lender does not require you disclose this information. But, if it will help and you have proof of the payment, why not use it?

Yearly DTI using Income Tax Returns

Your annual taxes shows all your income for the year. To show some different numbers for this example, let’s assume you have a pension that equates to an additional $2000 per year.

  1. Yearly income from full-time job = $15,080 plus the $2000 per year is $17,080 and this is what shows on your tax return.

      *** The formula for turning your reported income on your tax return into a 12 month salary is the same. ***

  1. $17,080 / 12 months = $1423.33 per month
  2. The front end DTI is still 36%. $1423.33 * 36% = $512.39.
  3. The back-end DTI is still 28%. $1423.33 * 28% = $398.53.

This increases you’re purchasing power approximately $5,000 more or $57,000.

The difference between the calculations is, the extra $2,000 will not show in your paycheck stubs. And, at this point, the lender is under no obligation to accept the extra $2,000. But, again, if you have proof of these payments and they are from a  reliable source use it.

When Could Using a Tax Return Hurt You?

Depending on your situation, tax returns are either helpful or detrimental to your situation. For example, if you are self-employed and your tax return shows too many deductions or shows you made no money it will not really matter what you are making right now. Lenders want to see your tax return and will generally use this method only when determining your buying power. To learn more about the obstacles of buying a home if you are self-employed, check out the article here.

The Purpose of This Article

The purpose of this article is not to persuade everyone to run out a buy a house just because the math works out. The purpose is to show you how to tax-returncalculate front end and back DTI and approximately how much you can afford. While the numbers show you can afford a mortgage even on a minimum wage salary, there might be other factors that prevent you from being approved for a loan. Or, you might have obligations that don’t show on a credit report that would prevent you from responsibly being a home owner.

No matter how much money you make if you are not paying living expenses now, or if you are having trouble paying any bills – it’s not the right time to buy a house. The last thing you want to do is purchase a house that you cannot truly afford. If you have to wait a couple of years to buy a house, then do that and make a budget for yourself in the meantime and ensure you buy responsibly.

Special Note: The calculations used above are not considering taxes being withdrawn from your paycheck because taxes are NOT considered when calculating your loan obligations. It is important to consider how taxes will affect your available income when doing your budget and you consider buying a house.