Even though any loan officer can pre-qualify you for a loan amount, ultimately, it is your responsibility to decide how much house you can afford. I once heard a mortgage sales manager tell his staff of loan officers to qualify their people for a higher mortgage than what they’d originally asked for.
He said, “If they buy a more expensive house, they will be happier.” Of course, his real motivation was for bringing in larger loans, not for their happiness.
But here’s the thing. Even if the home buyers were happier at first with their larger, fancier houses, how happy were they later when they discovered that their house payment was preventing them from going out to dinner and a movie? It’s not fun being a slave to your mortgage.
A good loan officer who is your advocate will never push you to get a bigger loan than what you’re comfortable with.
Unfortunately, just as often it is the home buyer who is pushing the loan officer to get them qualified for more than they should. This happens after they tour dream houses that are slightly above their price range. They fall in love with a house and think there must be a way to get into it.
This is partly why the mortgage industry created bad loans, such as the 2/28 teaser loan that had a low payment for the first two years and then went up, and negative amortization “pick a payment” loan that turned toxic for so many. A large number of these loans became unaffordable, causing the people to go into foreclosure. And we all know how that affected the U.S. economy!
Even though printed guidelines say your debt-to-income ratio should be 28% for the mortgage and 38% for both mortgage and other credit obligations, in reality, most lenders do not follow those rules. It is common for debt ratios to be pushed to 45% and some will go to 49.99%.
If your debt ratio on paper is 49%, but your real debt ratio is much lower because you have income that the lender won’t include, then taking the higher payment might be justified. For example, some people have a side business selling on eBay, at swap meets, or other venue. The lender might not include that business income for various reasons, so the lender’s calculated debt ratio might be higher than your reality.
How to Calculate Debt Ratio
To calculating your debt-to-income ratio (dti), use your gross income, before any deductions. Include the new, proposed mortgage payment, including property taxes, insurance, and mortgage insurance (if applicable) along with auto loans, student loans, credit card payment minimums, and anything else that shows up on your credit report. In general, the max dti for all expenses should not exceed about 35% to 40%. Stay on the lower end if you have children to support or if you like to spend a lot of money on entertainment, shopping, etc. and need a higher disposable income available after your mortgage payment.
If you’re not sure how to do this, any loan officer can help you with this calculation.