Real estate explainer

Can They Qualify?

A lender asks two questions about a family’s monthly budget. Will the house payment (PITI: principal, interest, taxes and insurance, plus any mortgage insurance and association dues) take too much of their gross income? And will the house payment plus every other debt payment? Set the house, the loan and the family, and see where they stand against the limits.

Real Estate Exam Lessons 5.2 and 10.2 · Real Estate Investing Lessons 4.1 and 4.5 · about 20 minutes

principal and interest
taxes, insurance, mortgage insurance, dues
other debts
ratio limits

The numbers

Housing payment

Loan-to-value

Housing ratio

Total debt ratio

In a spreadsheet

Put the loan amount in B1, the rate in B2 (as 6.5%), the years in B3 and the gross monthly income in B4. The calls below use your numbers.

The house and the loan

Example:

Price

Appraised value

Down payment

Interest rate

Term

Property taxes a year

Insurance a year

Association dues a month

Mortgage insurance (% a year, over 80% LTV)

Discount points

Rate with no points

The family

Gross income a month

Other debt payments a month

Housing ratio limit

Total debt ratio limit

28% and 36% are the traditional guideline taught for the exam. Real loan programs differ (FHA, VA and automated underwriting often allow more) and change over time.

What to notice

Two ratios, two tests. The housing (front-end) ratio looks at the house payment alone; the total debt (back-end) ratio adds car loans, student loans and card minimums. A family with no other debts is limited by the first; a family with a car payment is often limited by the second.

LTV uses the lesser of price and appraisal. If the house appraises low, the lender lends a share of the appraisal, and the buyer brings the difference in cash. Above 80% LTV, a conventional lender usually adds mortgage insurance, which protects the lender, not the family.

Why it works

The principal-and-interest payment is loan × r ÷ (1 − (1 + r)⁻ⁿ), with r the monthly rate and n the number of months. Add a twelfth of the yearly taxes and insurance for PITI. Each ratio is a payment divided by gross monthly income.

A point is 1% of the loan, paid at closing to lower the rate. It pays for itself only after cost of points ÷ monthly savings months, so it suits a family that expects to keep the loan a long time.

“The rich ruleth over the poor, and the borrower is servant to the lender.” Proverbs 22:7

Try it

Family: find the PITI of $1,936.68 by hand. Which test do they pass and which do they just miss?
Family: how much must the $600 of other debts fall for them to pass both tests at this price?
10% down: raise the down payment until mortgage insurance drops off. What happens to the housing ratio?
Points or not: the points cost $2,700. How many months until the lower payment earns them back? Is it worth it if the family will move in four years?
Change the limits to 31% and 43%. How much does the largest affordable price rise?

Rates, ratio limits and mortgage-insurance costs here are “in this example” numbers for practice, not a loan offer; real programs, credit scores and lenders differ. The largest affordable price keeps your down-payment share, tax rate (taxes ÷ price), insurance and dues the same and assumes the house appraises at the price. Money is rounded to the cent at each monthly line. No outside code, images or trackers.