How to Evaluate the Ability to Pay a Mortgage Loan

Determine whether you can afford to buy a new house.

Just because you're reasonably certain that you can afford a new mortgage payment, that does not mean that your lender will agree with you. Lenders use specific calculations to determine how capable a given applicant is of paying a new mortgage payment. These calculations help the lender avoid lending money to those whose low incomes or high debt loads render them incapable of working the new mortgage payment into their budget. You can evaluate your own ability to make mortgage payments by completing the same calculations on your own or with your lender.

Things You'll Need

• Credit scores
• Calculator

Instructions

1. Check your FICO scores by purchasing them directly from the Fair Isaac Corp. at MyFICO.com. Lenders use FICO scores when determining what mortgage interest rate you qualify for. Call several mortgage lenders and ask what sort of mortgage interest rate an individual with credit scores like yours could qualify for.

2. Calculate the monthly mortgage payment for a house in your price range. You can do the math yourself, use an online mortgage calculator or ask your lender to complete the calculations for you. Don't forget to add in the monthly cost of homeowner's insurance and taxes. If you plan to put less than 20 percent down on the loan, you must also factor the cost of private mortgage insurance into your monthly mortgage payment.

3. Compare the mortgage payment to the rent or mortgage you currently pay. If the new mortgage payment is less than you currently pay and you can comfortably afford your current payment, it stands to reason that you will also be able to comfortably afford the new mortgage payment. If the new mortgage payment is more than you currently pay, however, you may need to alter your budget.

4. Calculate your debt to income ratio by dividing your prospective mortgage payment by your monthly income. For example, if you earn $2,500 a month and your total mortgage payment, including taxes and insurance, totals $800, your debt-to-income ratio would be 32 percent. All lenders have different preferred debt-to-income ratios but, in general, lenders prefer that your debt-to-income ratio not exceed 30 percent.

5. Add up your monthly debts other than your current rent or mortgage payment such as your car payment, utilities, grocery bills and credit card payments.

6. Divide the amount of your non-mortgage monthly debts by your gross monthly income. The number you end up with is your overall debt ratio. Like debt-to-income ratios, all lenders' preferences vary. Typically, lenders do not want to see overall debt ratios that exceed 36 percent.

7. Talk to you lender about how your income and expenses measure up. If your debt- to-income ratio and overall debt ratio fall within your lender's parameters, your lender considers you capable of affording the new mortgage payment.

Tips & Warnings

• If your debt-to-income ratio or overall debt ratio is too high yet you have an excellent credit score, some lenders will make an exception for you.

• Paying down credit cards and other expenses prior to applying for a mortgage can help you qualify by reducing your total debt load.

• The credit bureau Experian does not sell FICO scores to consumers. While your lender can pull your Experian FICO, you cannot.

References

• MyFICO.com: Get the Score Lenders Use to Evaluate Your Home Mortgage Loan; 2011
• Federal Reserve Bank of San Francisco: Private Mortgage Insurance (PMI); 2011
• Zillow: Can You Afford a Mortgage?; 2011
• MSN Money; Credit Bureau Move Creates 'Secret' Scores; Liz Pulliam Weston; 2011

Resources

• Wells Fargo: What Lenders Look At; 2011
• The Federal Reserve Board: Looking For the Best Mortgage; December, 2007
• American Bankers Association: Do Your Research When Choosing a Mortgage; 2011