To determine how much a bank will lend for a mortgage, an underwriter will evaluate your debt-to-income ratio, the value of your property and your credit history. The lending bank will also want you to satisfy the three Cs of credit history -- capacity, capital and character -- which demonstrate your ability to repay the loan, sufficient assets to repay the loan in the absence of income and your bill payment history as illustrated by your credit report.
The LTV (loan-to-value) ratio is a critical consideration in a bank's decision to not only lend you money but also decide how much to lend for a mortgage. The LTV ratio is expressed as a percentage, and it represents the connection between the appraised value of the property and the total mortgage loan amount required. If you are making a down payment of $26,000 on a home priced at $130,000, the total loan amount required is $104,000. The LTV is calculated by dividing the mortgage amount ($104,000) by the estimated appraised market value ($140,000), then multiplying the answer by 100 for an LTV of 74 percent.
More on LTV Ratios
Most lenders are comfortable with LTV ratios of 80 percent or less, which means they are willing to give you a mortgage loan for as much as 80 percent of the total loan amount you require. Some lenders may be willing to offer you a 90 to 100 percent LTV loan if you are a low-risk, creditworthy borrower, but this may require you to pay for private mortgage insurance.
It goes without saying that lenders are first and foremost concerned with your ability to repay your mortgage loan. Your debt-to-income ratio (total income compared to total expenses) weighs heavily in an underwriter's decision on how much a bank will lend for a mortgage. There are two types of debt-to-income ratios the lender will examine -- the front-end ratio and the back-end ratio.
The front-end ratio, sometimes called the housing expense, demonstrates how much of your monthly pre-tax income would be necessary to make your mortgage payment. Typically, banks prefer that your total monthly mortgage payment -- including principal, interest, property taxes and homeowner's insurance -- does not exceed 28 to 29 percent of your gross monthly income. For example, if your annual gross income is $70,000, you would calculate your front-end ratio by multiplying that amount by .28 or.29 (depending on your lender) to arrive at approximately $19,600, then divide that answer by 12 (months) for a total estimated maximum mortgage payment of $1,633.
The back-end ratio, or total debt-to-income ratio, demonstrates how much of your monthly pre-tax income is necessary to meet all of your monthly debt obligations, including mortgage payments, car loans, child and spousal support, student loans and credit card bills. For most lenders, your total monthly debt obligation cannot exceed 36 to 41 percent of your gross monthly income. If your bank allows a limit of 39 percent, you can calculate your back-end ratio by multiplying your gross annual salary ($70,000) by .39 and dividing the answer by 12 (months) to arrive at $2,275 as your maximum allowable debt-to-income ratio amount.
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