How Much Money Can Be Borrowed for a Home Loan?
Mortgages are loans from banks that allow borrowers to purchase homes. These loans usually last between 10 and 30 years. As an assurance that the loan will be paid back, the borrower offers the home he is purchasing as collateral, something that can be seized by the bank if the borrower fails to make the payments. Because of the size of the loans, banks use several ratios to determine how much a person can afford to borrow.
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Front-End Ratio
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The front-end ratio compares your monthly income to the mortgage payment. Most banks do not allow your monthly mortgage payment to exceed between 26 and 29 percent of your monthly income. For example, if your lender used 28 percent as its front-end ratio and your monthly income is $2,800, your monthly mortgage payment could not be more than $784.
Back-End Ratio
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The back-end ratio compares the amount of debt payments you have to your total income. Even though your mortgage payment may meet the first test, if you have significant other debt, the size of the mortgage you can get will be reduced. The lender calculates the back-end ratio by multiplying your monthly income by between 33 and 41 percent, depending on the type of mortgage. Your total debt payments, including the mortgage payment, credit card debt, student loans and auto loans, cannot exceed this number. For example, if your lender used 36 percent as its back-end ratio and you make $3,000 per month with $200 in debt payments, your monthly mortgage payment cannot be larger than $880.
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PMI
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When individuals are unable to put up a down payment of 20 percent or more on their home, most lenders require the person to pay for private mortgage insurance (PMI) to protect the lender in case the borrower defaults on the loan. This amount will be added to the monthly mortgage payment until the borrower has at least 20 percent equity in the home.
Fannie Mae Mortgage Limits
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Fannie Mae is a government-sponsored company that buys mortgages from banks and lenders. The amount of the mortgage is limited based on the number of units and the location of the home. There are two regional categories, the lower 48 states, the District of Columbia and Puerto Rico; and Hawaii, Alaska, the U.S. Virgin Islands and Guam. Within these regions, there is a general limit and a high-cost area maximum. The high-cost area allows for higher mortgage amounts in localities that have higher-priced homes. Each year, the amount of money that it can pay for a mortgage is adjusted based on inflation. For 2009, the limit on a single-family home in the lower 48 states is $417,000, unless you purchase a home in a high-cost area, in which case the limit can go as high as $729,750.
Other Loan Costs
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In addition to the down payment and monthly payments, you must pay a number of closing costs when you take out the mortgage. There are two types of points that you may pay: discount points and origination points. A point represents a fee equal to 1 percent of the home's value, so if you had to pay two points on a $130,000 loan, that would add $2,600 to the cost of the loan. Discount points cost the same as origination points but come with the benefit of lowering the interest rate on the loan. Generally, each discount point paid will reduce the interest rate by 0.25 percent.
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