How Much House Can You Afford
How much house can you afford or really how much can you pay for your investment property.
Now what I am going to talk about is really going to apply for both.
Whether you are buying your first home or a second home or whether you are buying an investment property.
What happens when you go to qualify (and this is assuming you are going to get a mortgage).So there are two ways to look at it.
First of all it’s how much can you afford from a bank’s perspective and how much can you afford knowing how much cash flow you have coming in.
First one is how much can you qualify or how much you can afford according to the bank.
So what the bank does is, it looks at two variables.
The first one is what’s called a GDS, Gross Debts Service. What it is all the costs associated with owning a property. For example it is, your mortgage payment, your taxes, your insurance and your heating.
So this is how the ratio works, i’ts the amount of expenses that you are going to incur for carrying that property.
So let’s say what I mentioned there comes to $1000.00 dollars and lets say you make an income of $40,000.00. So $40,000.00 is just over $3600.00 a month. So what the banks will do is they try to use about 1/3 of your income as a guideline so actually 32%.
So a third of $3600.00 is $1200.00. So $1200.00 is what they will allow you to carry for a particular property for you to be able to buy a home with those expenses.
The other variable that they take into consideration is what is called the TDS, total debt service ratio. What that is, is they add in a whole bunch of your other liabilities, your other credit cards or whatever debts you have.
So let’s say you are still only making $40,000.00 so again the rough math is $1300.00 a month. Now what the banks will allow is usually anywhere from 44-49%. So lets say 50%, so half of your $40,000.00 is now $20,000.00 divided by 12 per year so that is just under $2000.00.
So what happens is you can not have debt in other areas that would allow you to exceed that total debt service ratio. So for example if you had a car payment, a credit card payment and another loan payment that le’ts say came to another $1000.00 well that means your total debt including your housing expenses is $2000.00 and if you use that 44% ratio you would have to earn an income that would allow you to carry that total debt.
Now that’s again for what the banks looks at. The banks have some flexibility there too depending on your credit score. If your credit score is low, if its in the 600 they won’t have lots of flexibility they want you to come around 44%. If you have a credit score of 700 or 800 then they might let it go up to 49%. Again, all this varies on the banks.
When you are buying an Investment Property the other thing that you can add to this whole scenario is rental income.
So I talked about your earned income. If you are adding rental income, they will allow a certain portion of your rental income. I say a certain portion because they want to be conservative they know that you have operating expenses. Some banks will allow 50% some will allow 75%.
So le’ts say your rents are $2000.00 a month, they might allow $1000.00 a month towards your income which would increase your probability of getting approved cause now you’re ratios are higher.
Again your total expenses incurred by rental property have to be counted for. So its not really fair when you look at it that way. They want you to claim all the expenses for that property but they dont let you claim all the income. What they are trying to do is they are trying to help you for any unforeseen circumstances. So for example: any major expense or any unexpected events.
So that is how the banks calculate it. What you can calculate is depending on the cash flow and depending on your rental property it may be that you think you can carry a property higher than what the banks will allow. Now what you can do then, is you may go to a B lender or C lender and you may be able to get a loan at a higher interest rate.
If the banks are going to give you a mortgage at 3% but I have lenders that will give loans based on 5-6% but they are taking a higher risk. They will look at the total deal, they will look at the income does it make sense, they will look at the expenses,they age of the property so they really do a better job of evaluating the whole investment.
Hopefully that answers your question about how much house you can afford or how much investment property you can afford using those ratios.