The debt to income (DTI) calculation used by mortgage companies to qualify a customer for a home loan does not include lifestyle/savings patterns. The mortgage company determines DTI by dividing monthly debt by monthly gross income. This is the reason it is so important for you (the person that is committing to pay the mortgage for the next 15-30 years) to have an idea of a comfortable payment range prior to being pre-approved for a mortgage. The mortgage company will preapprove you for a specific loan amount, but to ensure a successful home purchase, you really need to sit down and determine a comfortable payment range that works within your personal budget.
Here is a formula that will help you to determine a comfortable payment if you are not making a rental payment:
- Write down everything you spent over the past month. Be as thorough as possible. If you bank online, then pull up your online bank statement to determine your expenditures. For this calculation, exclude any one-time expenditures, they will be included in step two.
- Take that monthly amount and multiply by twelve. Add any yearly expenses that would not be on this list. For example, vacations, Christmas time, New Year's parties, birthday parties, back to school, this should give you a yearly lump sum. Divide this amount by 12.
- Look at your most recent check stub(s) to determine your NET monthly pay. (Net pay is what you receive after taxes and insurance are deducted from your pay check.) If you are paid bi-weekly, you will need to multiply the net amount by 26 and then divide by 12. If you are paid weekly, you will need to multiply and this amount by 52 and divide by 12. If you are paid bi-monthly, you will need to divide this amount by 24 and multiply by 12. If you are paid monthly, you will use your net payment listed on the paystub.
- Subtract the answer from #2 from the net monthly income. The amount left over from step 4 is the amount you have left over to help determine your payment range. But you are not completely done with the formula.
- Deduct $450 from that payment for utility bills and add at least $100 for savings.
- NOW you have a close approximate for a comfortable mortgage payment.
For example: Step 1. Monthly expenses spent the prior month are $932. Step 2. Annual expenditures = $3500. 932x12 = $11,184 +3500 = $14,684 divided by 12 = $$1,223.67. Step 3. Net income paid bi-weekly is $1,583. $1,583 x 26 = $$41,158/12 = $3,429.83. Step 4. $3,429.83 -$1,1223.67 = $2,202.20. Step 5: $2202.20 - $550.00 = $1,650.20. In this example, the comfortable payment is $1,650.20. But the customer did not want to go this high, so he pursued a $1,400 payment which gave him an extra $250 per month for unexpected expenditures.
*Note - if there is not any additional money left over, you need to adjust your budget which a good housing counselor can help with. For a list of housing counseling agencies in your area, please click here: Counseling Agencies
Use this formula if you are renting or already own a home to determine a comfortable payment range :
- Take inventory of your expenses over the past three to six months.
- Rate your comfort level of your current expenses on a scale from one to ten. One being very comfortable and ten being the least comfortable.
- If the comfort level is five or less, then move to step four. If the comfort level is greater than five, then you have determined a payment at where you are currently, or you need to move down in payment.
- Create a mock budget with a new estimated house payment, higher utilities and upkeep.
- Review your savings patterns to see if the new estimated payment is going to fit into your lifestyle.
If you a financial planner and CPA on your team, reach out to them to let them know what you are planning to do and seek out any wisdom they may have to share with you. It may slow you down in the process to take the time to evaluate your expenses, but your check book and stress levels will thank you every month when it is time to make pay the mortgage.