How do you determine how much you can spend on a new property?

Question

I graduated school last May and want to dip my toes into REI by "house-hacking" (in Cleveland). Per some other contributors recommendations, I'm in the process of trying to get pre-approved for an FHA loan, but some of the lenders have asked me for property info, such as Purchase Price and County/State information. Before I answer these questions, I would like to hear how everyone determines how much they can spend on a house, so that I can narrow down my universe.

Christopher Phillips · Answer

@Griffin Myers

Lenders use a few calculations in determining how much you can afford.

In general, they look at your total income and debts and FICO. You are also looking at is the potential of using the rental income in the calculation.

They may or may not include the rental income in the calculation. Depends on the lender. Most might not. You're supposed to have two years of steady landlord experience for them to include the rental income. However, I've seen some local lenders work around that.

That being said, you should also consider the possibility that you might have a vacancy for a long period of time and need to be able to carry all of the expenses on your own. If the only way you can afford a property is when you have rental income, you can't afford it.

Without looking at a specific property, they can only tell you how much you can afford without the rental income.

The biggest factor is your monthly payment vs your gross income.

Lenders look at two ratios: living expenses and then total debts.

First ratio - Total living expenses (mortgage, property taxes, home insurance) vs monthly gross income. Should be no more than 28%.

Second ratio - Total monthly debts. living expenses plus monthly debts like student loans, credit card payments, car payments, alimony, etc. Should be no more than 43% for FHA. 36% for Conventional.

And, you have to have the down payment, closing costs, and reserves.

Since you're looking at a duplex using FHA. You need to have the down payment of 3.5%, plus the closing costs 4%-5%, and three months in reserves for mortgage payments.

If you have the average price for a duplex in your area, then a lender can work with you to develop an estimate.

Griffin Myers · Answer

Thanks for the response. I was more interested to see if there was a calculation to come up with some rough approximation, on max purchase price.

Alex Deacon · Answer

@Griffin Myers ask yourself this question. How much can you afford monthly. Is it a $600 a month mortgage payment or a $3,000 a month payment. That will dictate how much you can spend.