Reader question: “I will be purchasing my first home in 2015 and plan to use an FHA loan. How much money could I borrow to buy a house based on my income? I make about $80,000 per year. Are there calculators that can tell me how much of an FHA payment I can qualify for with my salary?”
There are all sorts of mortgage calculators available online these days, but they can’t give you the number you want. That’s because you are asking two separate questions:
- How much of an FHA loan can I qualify for?
- How much of a mortgage payment can I afford?
These are two different questions. The first has to do with loan-approval criteria. The second has to do with your own budgeting and affordability. So let’s tackle them one at a time.
Short answer: Here’s the gist of this article in 100 words or less. The general rule for FHA loans is 43% debt-to-income ratio. This means your combined debts should use no more than 43% of your gross monthly income — after taking on the loan. But there are exceptions. If you have a lot of cash in the bank, excellent credit, and/or other sources of income, you could get approved with a ratio above 43%. Still, it gives you some idea where lenders draw the line these days.
How Much of an FHA Loan Can I Qualify for?
Income is one of the factors that will determine who how much of an FHA loan you can qualify for — and for obvious reasons. But it’s not the only factor. The total amount of debt you carry will also play a big role. In fact, mortgage lenders consider these two things together, using a formula known as the debt-to-income ratio, or DTI.
The DTI is a comparison between the amount of money you earn each month (your “effective income” in FHA lingo), and the amount you spend on your recurring debts. You have two of these ratios.
- Your front-end ratio includes housing costs alone.
- Your back-end ratio looks at all of your recurring debts including credit cards, car payments, etc.
The general rule for FHA loan approval is 31/43. This means your total debt load should use no more than 43% of your gross monthly income.
Here’s an example using a gross monthly income of $6,000. In this scenario, the borrower’s total monthly debts (including the mortgage payment and other recurring expenses) should add up to no more than $2,866 per month. The math looks like this: 6,000 x .43 = 2,866.
The housing payment in this scenario should not exceed $1,860 per month (because 6,000 x .31 = 1,860).
But there are exceptions to the 31/43 rule of thumb. Lots of them. If the lender can find and document “compensating factors” that show the borrower is a strong candidate for an FHA loan, they can allow for a higher back-end DTI ratio. Up to 50% in some cases. But again, it varies from one lender to the next.
Compensating factors might include:
- verified and documented cash reserves,
- minimal increase in housing payment,
- significant additional income not reflected in effective income, and/or
- residual income.
Your credit score comes into the picture as well, but it doesn’t have as much influence as your income versus debt. In short, if you have excellent credit you might be able to qualify for FHA financing with a debt ratio above the “soft” limits mentioned above.
This might be a bit confusing, because we are dealing with hypothetical scenarios. When you apply for a loan, the lender will look at a wide variety of factors. So the best way to find out where you stand is to talk to a HUD-approved mortgage lender. Ask them: How much of an FHA loan can I qualify for? They’ll look at your income level, your debt situation, and your credit and borrowing history to answer this question.
How Much of an FHA Loan Can I Qualify for?
When you ask how much money you could borrow, you’re only looking at half the picture. You also need to ask yourself, “How much can I actually afford to pay each month?”
Believe it or not, it’s possible to be approved for a home loan that’s too big for you — or one that might become unaffordable down the road, due to changes in your financial situation. This is one of the reasons why people end up in foreclosure.
Setting Up a Housing Budget
So before asking a lender how much of an FHA loan you can borrow, you should establish a monthly budget for yourself.
First, you should compare your net monthly income (your “take-home pay”) to your overall monthly expenses. When I say expenses, I’m talking about everything you spend money on each month that is not housing-related. This includes gas, food, credit card bills, car payment, entertainment, savings account contributions. Everything.
The money left over is what you have available to put toward a mortgage payment. You don’t want to use this entire amount, because that would eliminate your emergency funds. But it does give you a starting point for your monthly home-buying budget.
You must also consider your future job security, as well as that of your spouse (if applicable). None of us can predict the future, but there’s always a possibility that one of you could be laid off in the future. Because of this possibility, it’s rarely a good idea to stretch both incomes to cover the house payment. You want to have a cushion, just in case your income shrinks for some reason.
Of course, there are other unforeseen circumstances as well. In your budgeting, you may not account for a major injury or illness that racks up big hospital bills. You just cannot predict that sort of thing. But it can happen. If you don’t allow for such surprises within your budget, you won’t be able to afford them when they come along. So give yourself some financial breathing room.
After you have determined what you can spend each month, you can move on to the next step of the process and get pre-approved by a lender. This is when you find out how much of an FHA loan you can qualify for, based on the factors we discussed earlier.
Do Not Ask a Lender What You Can Afford
Many first-time buyers rely on their mortgage lenders to tell them how much of a house they can afford. This is a mistake. It’s possible to get approved for a home loan that’s too big for you. Just ask one of the millions of Americans who went through foreclosure over the last few years.
Lenders can tell you how much you are qualified to borrow. But they cannot tell you how much you can comfortably afford to pay each month. These are two different things.
Just because a lender approves you for a certain amount doesn’t mean you have to spend that much. The approval amount could very well exceed your comfort zone. This is a fairly common scenario. So before you start applying for loans or contacting lenders, you need to set your own monthly spending limit.
Disclaimer: This article answers two important questions. (1) How much of an FHA loan can I qualify for? (2) How much of a mortgage can I afford? It’s important to think of these questions separately, because they are two different concepts. This article provides a general overview of mortgage qualification factors and budgeting concepts. Every lending scenario is different. As a result, some of the concepts and guidelines above may not apply to your situation. This article does not constitute financial advice.