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Owning a home is a pipe dream for many. And here is why it is on the decline.
When you’re shopping for a house and considering a mortgage loan, establishing what you can afford for house payments can be a lengthy process. You have to run calculations, get updated payment scenarios from your mortgage company, and determine whether or not you can qualify.
With all these moving parts, we hope it comes as a relief to hear there’s a simpler way to calculate a home payment. This simple solution will be a huge help in a competitive market that doesn’t allow for extended number crunching.
Terms to know
Before we get into the nitty-gritty, it will be helpful to know these two key terms when using our easy house payment formula.
1. House payment or PITI
PITI is an initialism used to reference the four factors that influence your monthly house payment:
- Principal is the amount borrowed, specifically how much of your loan you’re scheduled to pay off each month.
- Interest is how much it costs to use your loan, and your monthly payment is based on your interest rates.
- Taxes refer to the property taxes rolled into your monthly house payment and are sometimes called an escrow or impound account.
- Insurance is the amount of the mortgage payment that goes toward hazard and fire insurance.
2. Debt-to-income ratio (DTI)
Important for determining how easily you’ll be able to pay off your debts, the DTI is the percentage of your total monthly debt against your monthly income. In math terms, it looks like this:
(PITI + monthly liabilities) ÷ monthly income = DTI
Most lenders prefer your DTI stays at or under 45%, so it’s important to consider your other monthly liabilities alongside your PITI when getting a mortgage.
The basic house payment calculations most lenders won’t share
Now that you’re familiar with PITI and DTI, you’re ready for this simple truth: for each $100,000 you borrow, expect a monthly mortgage payment, or PITI, of $725.
It’s true! In most cases, your principal, interest, property taxes, and home insurance for $100,000 will come out to about $725 each month. Here’s a handy table for reference:
|AMOUNT BORROWED||APPROXIMATE PITI|
You can easily add half of $725 (that’s $362.50) if you’re trying to calculate for an extra $50,000. Or you can divide the loan amount by $100,000 and multiply the result by $725 to get the estimated PITI for your loan.
The ins and outs of calculating PITI
Let’s look at an example. Say you want to buy a $350,000 home. You want to know whether the payment is affordable and whether you’ll meet your lender’s debt ratio thresholds.
Pretend you already have a 20% down payment ready, which is $70,000 for a $350,000 home. So in total, you’ll be borrowing $280,000. Divide that by $100,000 and you get 2.8. Using this information, the basic house payment formula will look like this:
$725 x 2.8 = $2,030
To spell it out, we know that when you borrow $100,000, your PITI will be about $725 per month. When we divide $280,000 by $100,000, we get 2.8. Similarly to how multiplying $100,000 by 2.8 will result in the full loan amount, multiplying $725 by 2.8 will give us the total PITI amount. So the total PITI would be $2,030 per month.
The ins and outs of calculating DTI
Once you’ve calculated the PITI, make sure you’ve got a debt-to-income ratio a lender will approve of. Remember, the highest DTI most lenders will allow is 45%. Continuing with our example and using an income of $4,750, here’s how to find the DTI for a $2,030 PITI if you have no other monthly liabilities:
$2,030 ÷ $4,750 = 42.74%
As you can see, you simply divide the PITI by your income. In this case, the result is 42.74%, which is low enough to possibly qualify for a loan.
The application of monthly liabilities
Remember to include any other monthly liabilities you have when you calculate your DTI. Let’s see if you can still reasonably afford the house with hypothetical monthly liabilities.
Pretend you have a car lease payment of $300 a month and credit card payments of $80 a month. This changes our previous DTI formula like so:
($2,030 + $300 + $80) ÷ $4,750 = 50.74%
With those debts, you would have a 50.74% DTI, which means you likely wouldn’t qualify for that large of a loan. That’s a rather different situation, so don’t forget to include your monthly liabilities when calculating DTI.
Personalizing your DTI
Your monthly income and expenses may be very different from our hypothetical scenario. Try plugging in your PITI with the formula below to get your personal DTI, and make sure it’s below 45%:
(PITI + monthly liabilities) ÷ monthly income = DTI
Remember, even if your DTI is below 45%, you need to consider your lifestyle and other living costs when deciding on a home. Are you willing to be house poor for a large mortgage, or will you be just as happy with less home and more spending money each month? The choice is up to you!
Factors beyond the formula
Our formulas for PITI and DTI are best for a solid estimation, but they’re not exact for every unique situation. Here are some other factors that will affect your monthly house payments:
- Private mortgage insurance (PMI) comes into play when you have a down payment under 20%. PMI helps lenders offset the risk of you defaulting on the mortgage.
- Large down payments, on the other hand, will positively influence your borrowing power.
- Assets and reserves need to be disclosed to most lenders, and you’ll need two months or more of PITI in the bank to meet their requirements.
- Credit scores can influence interest rates, and if your score is below 620, you may not qualify for a home loan. Every month, check your credit scores for free on Credit.com to see where you stand.
Original article found at: https://www.usatoday.com/story/money/personalfinance/real-estate/2017/12/22/home-buying-quick-formula-determine-your-house-payment/963414001/