Can I Afford this Home?

Prior to making a mortgage loan, lenders will require a potential borrower to qualify and demonstrate an acceptable credit record and sufficient income to support the loans scheduled payments. This credit evaluation relies on two basic criteria to determine maximum payment amount, and, relatedly, the maximum total loan and house amount that the borrower can afford.

Generally, the guidelines specify a range for each criterion. This practice provides each lender with the flexibility to adapt its requirements to a particular loan applicant.

The two borrowing criteria used by most lending institutions are as follows:

	Thefront-end , or maximum allowable housing expense ratio, which maintains that the applicants totalmonthly expenditures for housing (as measured by a years worth of PITI payments), cannot exceed 25%29% of the borrowers annual gross, orbefore tax income.
	Theback-end , or maximum allowable monthly housing expense and long-term debt ratio, which maintains that the total of allmonthly debt paymentsincluding the PITI mortgage payments, auto loans, and all other debt paymentscannot exceed 3341% of applicants monthly gross income.

Next week, your friends Paloma and Anthony want to apply to the Fourth Global Bank for a mortgage loan. They are considering the purchase of a home that is expected to cost $125,000. To prevent their possible embarrassment at the bank, and given your knowledge of personal finance, theyve asked you to help answer the following questions by completing the home affordability worksheet that follows:

	What is the minimum and maximum annual housing expense allowable by the bank, given Paloma and Anthonys combined annual income?
	What is the minimum and maximum total monthly debt obligation allowable by the bank, given Paloma and Anthonys combined monthly income?
	Given their existing debt obligations, what is the maximum additional mortgage obligation that Paloma and Anthony can reasonably expect the bank to consider next week?

To assist in the preparation of the worksheet, Paloma and Anthony have collected the following information:

	Their financial records report a combined gross, before tax, annual income of $125,000, and current (pre-mortgage) installment loan, credit card and car loan, debt of $1,823 per month.
	Their best estimate of the interest rate on the new mortgage is 7.5%, and they are interested in obtaining a 15-year loan.
	They have accumulated savings of $32,500 that can be used to satisfy the homes down payment and closing costs.
	The lender requires a minimum 20% down payment.

Note: When completing the form, round each dollar amount to the nearest whole dollar. Unless labeled differently, all of the values in the worksheet represent dollar amounts. Also, this problem contains additional information that may not be necessary to generate your solutions to the questions.

Home Affordability Worksheet
Based on the Front-end ratio	High Value	Low Value	Amount
1. Annual income
2. Lenders front-end income affordability ratio	29%	25%
3. Maximum allowable annual housing (PITI) payment
4. Maximum allowable monthly housing (PITI) payment
Based on the Back-end ratio
5. Monthly income
6. Existing monthly installment payments
7. Existing monthly installment payments as percentage of monthly income			%
8. Lenders monthly installment loan affordability ratio	41%	33%
9. Maximum amount of total monthly affordable installment debt
10. Maximum monthly mortgage payment (PITI), given existing debt payments

Grade It Now

Save & Continue

Continue without saving