As the median home price continues to increase. You might be wondering how much income do I need to actually qualify. For a loan and how in the world does a lender figure out how much home you can afford. You're looking to apply. You go talk to a lender and they're like, here, you can afford this much.
We'll give you a loan for this max purchase price. Where in the world did they get that number? I'm going to show you all the math and what goes on behind the scenes. So you can understand where they're coming up with this number, so you can help change it if you need that to increase.
So I'm going to show you based on the four main loan types, conventional FHA, VA, and USDA, the minimum income needed to afford the median home price, which is 347,500 at the time this blog was posted.
So here's the scenario that we'll be walking through. We're of course going to be the median home price, we're going to do a 3% rate. So each loan is probably going to have a different interest rate with it. We're just going to try to keep it all the same 3% interest rate across the board. We're also going to do minimum down payments.
So conventional 3% down FHA 3.5% down VA 0% down and USDA 0%. And then we'll do 1.1% and annual property taxes.
.35% in homeowners insurance, we'll do zero homeowners association fees and then $500 a month in debt. And so these monthly debts, minimum, monthly debt payments. Things like a car loan, credit cards, student loans. It does not include rent utilities or any other types of expenses or bills like that. So again, we're going to be using 347,500. Something interesting to note is that the median across all home prices is $347,500.
So with conventional loans, the median price for people purchasing with conventional is 386.6k, with FHA it's 255.4k, VA it's 324.3k and USDA, unfortunately, doesn't have any data on this, but we'll cover a USDA loan as well.
It's mainly through this number called the debt-to-income ratio. Basically, it's a percentage that says how much of your monthly gross income is debt payments is the minimum monthly debt payments. And this is going to be adjusted by the risk profile. So we're going to be looking at the maximum. Each loan has its own maximum debt to income ratio as a percentage. However, if your credit score is lower if the loan is riskier to the lender, then that maximum is actually going to be lower for you. So we're going to assume the risk profile is at its best. Maybe you have an extremely high credit score and there are no other risk profiles in the loan. And so we're going to just look at the maximum debt to income ratio so we can see the absolute minimum income required here.
There's a front-end and a back-end.
This is the monthly housing payment divided by the monthly gross income, and I'll explain why it's gross in a minute.
The back-end debt-to-income ratio is the same, except we're going to add in the monthly minimum debt payments.
And so the lender basically wants to see what portion of your monthly income is being used towards either the future mortgage payment or the future mortgage payment, plus the debts that you're already paying minimum monthly.
We only get to take home our after-tax pay and use those dollars. The reason why lenders want to use gross is because the net income can be manipulated. And then that wouldn't actually be fair for everybody with the gross income lenders have already factored in taxes into the debt-to-income ratios. So they've already factored in the taxes that you pay. If we were just looking at net income, it'd be very easy for somebody to manipulate their W-4 to change withholdings with how much tax.
Are taken out or there are other withholdings that are included inside of a pay stub that you might have things like garnishments or child support or retirement accounts. There are those things in there as well. So you're using net income when you figure out if you can afford a home. Not what a lender does to see how much loan they'll give back to you.
The debt-to-income is what the lender uses to determine your risk of paying back the loan. So it's very important to remember, it's not what you should use to determine if you can afford a home. You affording a home is about your budget and what you're comfortable paying every single month. Not what the lender tells you.
You never want to go with the lender just says, here you can afford this much. The lender is only looking at how risky it is to give you a certain amount of money, a maximum loan it's up to you to decide, should I take this on? Is this a good decision or not? Because only, your financials. Only you know the money that you have every single month that you're using and what it's going towards.
Please don't make them your financial advisor because they are not. All they're doing is they're giving you a loan and they're telling you how risky they think that loan is. They're going to say, this is what we're willing to give to you, just because they're willing to give it to you. That doesn't mean you should take it.
So what we're going to do is we're going to look at maximizing the debt-to-income ratio as an exercise, not as a recommendation, I'm not recommending you do this. What I'm doing is I want to show you the maximum debt-to-income ratio so we can see the minimum income needed for each of these loans.