“As [Candice] looked over my two years of tax returns and a statement I pulled together of projected income for 2013, she just started shaking her head and bluntly said, “Ariane, you just have to make more money!” Yes, I know. I listed some commissions that were going to come through and she nodded and said great but that I was still nowhere near where I needed to be. And then she did something no one had been able to do up to that point. She took out a piece of paper and explained to me how I would be able to qualify. She started with our projected cost to construct the house and worked backwards. All of a sudden it was like we were back in high school, with her explaining a complicated calculus equation to me. I learned how to calculate my debt-to-income ratio, how mortgage payments factor in, and that W-2 income is always preferred to 1099 income, no matter how many 1099 forms I had. Security, not quantity, is what really counts.”
(Chapter 5, pg 41)
Embarking on your home building (or even home buying) project does not begin by looking at floor plans and dreaming about the square footage you would have. I recommend starting by determining your financial worth: figuring out your debt-to-income ratio (DTI). These two exercises, which are also listed in the book’s appendix, will help you figure out how much of a loan you will qualify for.
The preferred DTI ratio is 43 percent or less, meaning that the overall debt had to be 43 percent or less of my monthly gross income. This percentage seems to waver a bit (not sure what it will be like with these new market conditions) but what lenders are looking for is less than 45 percent debt to income.
Example 1: How much money should I make?
A person has a monthly student loan payment of $250 and credit card debt with a minimum payment total of $100. They want to buy a house worth $200,000. Can they afford it?
When starting with the home value, begin by calculating the mortgage (monthly mortgage payment, taxes, and insurance). The principle and interest payment (you can find various mortgage calculations online) on a 30-year mortgage of $200,000 at 4.5% interest (depends on the market) is $1,013. Let’s assume this house is in Houston, Texas, and is located in a flood zone. It would cost approximately $4,518 in property taxes annually ($375 monthly), hazard insurance would be approximately $2,000 annually ($167 monthly), and flood insurance would be $700 annually ($60 monthly). The monthly house payments come to a total of $1,615. With student loans and credit card debt, the total monthly payment is $1,968. Since debt / salary = DTI, the equation is as follows:
$1,968/X = .43
To solve for “X” or the salary, divide 1,968 by .43, yielding $4,577, the minimum monthly gross salary amount necessary in order to afford a $200,000 house located in a flood zone in Houston, Texas. So, you would need to earn an annual salary of $55,000.
Example 2: How much payment can I afford?
You can also start by using your current salary to see how much house you can purchase. For example, let’s say your monthly gross salary is $3,500 (annually $42,000), with the same $250 student loan payment and the $100 minimum payment on credit card debt. The equation is now this:
X/3500 = .43
To solve for “X,” or debt, multiply your salary by .43 to arrive at the total amount of debt you can have which is $1,505. Subtracting your existing debt obligations of $350 leaves you with $1,155, the maximum amount your new house can cost on a monthly basis. This next step takes some trial and error to figure out the exact value. Essentially, you could afford a $140,000 loan since the principle and interest for a 30-year mortgage at 4.5% interest would cost $733, property taxes for a house outside the Hwy 610 loop in Houston would be a little lower at $258 per month, home insurance would be about $100 per month, and let’s just keep flood the same at $60 per month. The total payment you can afford is $1,151, just barely below the $1,155 maximum