How to determine how much home you can qualify for

Question

I have a few people interested in a house that I am advertising Rent to Own, and i'm having a little trouble pre-qualifying them. I'm trying to get an estimate on how much of a home they can afford based on their debt and income. Is there a formula that I can use to determine this? Let's say I have someone who makes $5000/m gross. Assuming the lenders debt to income ratio requirement is 40%, we have $2000 to work with. We pull their credit and it shows they have $550 in monthly debt. So available housing costs should be $1450. How do I calculate, based on this number, how much of a home they can buy?

Also, the house that I'm advertising is available on a 2 year lease. Would you all agree that 2 years is enough time to fix most of the common credit problems? If not, how long would you say most will need?

Also, what credit situations should I avoid? One of the ladies that filled out my application admitted she had been through foreclosure. If it happened yesterday, I know that's something I can't fix. However, if it happened 5 years ago, could I move forward with her?

I'm not looking for an exact answer, but rather a rule of thumb. I just need to have an idea of what I can and cannot fix.

This is my first house by the way.

Andrew Postell · Answer

@Brandon Stewart this post might take a full time, 40 hour job to really understand how to properly qualify everything you talking about in this post.  I'll do my best to tackle each point with as much brevity as possible. DTI is different depending on the loan type, governing body, and bank.  It sounds strange but if FHA states their DTI is 50% a bank can actually have say "our FHA loans will only be 40%".  These extra rules are called overlay.  The general numbers for each program are 45% for Conventional Loans, 55% for FHA/VA/USDA.  Exceptions can be made to make each of these DTI's be higher or lower but those are the general numbers.

To calculate DTI not only do we take all the debts included on an individual's credit but the new house payment as well.  And in that house payment calculation we include the taxes and insurance on that home.  So if taxes are $100 per month and insurance is $75 per month then those are added on top of all of the debts.  AND we also include HOA, Child Support, and PMI among other things.

How long does it take to fix credit?  This certainly depends on what's going on with credit. Some credit issues can be fixed in 5-7 days.  Foreclosures/Short Sales/Bankruptcies each have a waiting period for Conventional Loans/FHA/VA/USDA loans but portfolio loans can be a solution to help someone day one after a major issue occurred. So there are some loans that won't care about a major credit event as long as someone has a large enough down payment (usually 20%).

I hope some of this information is helpful.  Thanks!

Brandon Stewart · Answer

Thanks @Andrew Postell I learned a lot from your post. I think its better for me to leave this area of pre-screening to a professional.