Calculate Home loan eligibility

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By Lisa Smith

"How much house can I afford?" It's a critical question that every homebuyer faces, and one that many people answer by going to a lender and taking out the largest mortgage that the lender will approve. While this strategy will help you get the largest, most expensive house that you can qualify for, being eligible for a loan and being able to afford the property aren't necessarily the same thing. (For more insight, see Mortgages: How Much Can You Afford?)

From a lender's perspective, loan eligibility is based on a formula. The most common rule of thumb is that your monthly mortgage payment should not exceed 28% of your gross income. This calculation includes more than just the base price of the house. Consider, for example, a $50, 000 gross income. Based on 28% of that amount, the mortgage payment would be $14, 000 per year or $1, 166.66 per month. That $1, 166.66 needs to cover all four potential components of a mortgage: principal, interest, taxes and insurance, often referred to as PITI.

If your credit history is good, the lender may let you take out a mortgage with a monthly payment equal to 30% or even 40% of your gross monthly income. In our example, 40% would get you a yearly mortgage payment of $20, 000 or $1, 666.66 per month. The $500 per month difference would let you afford a more expensive home, but you should take a close look at your finances before making such a decision.

Gross Vs. Net Income
Although mortgage eligibility is based on gross income, your monthly payments are made from your net income. This means that your ability to afford the payments can look quite different once the mortgage actually needs to be paid. That $50, 000 gross income is reduced to $36, 000 net after 28% goes to pay taxes. Taking $20, 000 out of that to pay the mortgage leaves you $16, 000 to live on for the year. On a monthly basis, that's $1, 333.33. Factor in a car payment, credit cards and student loans to cover the cost of your education or tuition bills for your children and there might not be much left over at the end of the month. Although you may be able to qualify for that $1, 666.66 loan on paper, actually taking it might not be the best financial move that you could make. On the other hand, if you are debt free and have a rainy-day fund stashed away in case of emergencies, a mortgage that takes up such a large chunk of your gross income may not be a problem. (For more insight, read Are You Living Too Close To The Edge?)

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2011-06-06 08:25:17 by odion

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