One of the most frequent questions we get is, “How much house can I buy with my income?” Recently, a reader asked us that question. He mentioned that he and his new wife earn $110,000 annually. He wanted to know first whether it was possible to buy a house in the Bay Area. Here’s what I told him:
Yes indeed. How much home you can buy depends on three things:
- Your down payment
- Your credit score
- Your other debt payments.
Lenders make lending decisions based on “debt to income ratio,” or DTI. We calculate it by adding up the total house payment including taxes, insurance and mortgage insurance, if any, plus any monthly debt obligations with ten months or more remaining. This would include car payments, student loans, credit card minimums and alimony/child support. The sum is called “total debt.” That number, divided by your gross monthly income, produces the DTI. Lenders will allow a DTI as high as 50% for conventional loans.
Your down payment will obviously affect your payment because of the size of the loan. If your down payment is less than 20%, lenders will require mortgage insurance. This limits their risk in the event a borrower defaults and the property is sold at foreclosure auction. The mortgage insurance, the cost of which is determined by a combination of loan-to-value ratio and credit score, is part of your housing expense in calculating DTI.
Your credit score will determine the rate you get. Lenders selling their loans to Fannie Mae or Freddie Mac use “risk-based pricing.” This means that they consult a table containing credit scores on one side, and loan-to-value across the top. Where a borrower’s two numbers interest, the lender will determine how much to adjust the interest rate.
The minimum required score for a conventional loan is 620. A borrower with that score can still get approved for a loan, but their rate will be approximately .75% higher than for a borrower with a 740+ score. The same holds for the cost of mortgage insurance. A borrower with a 740 score and a 90% loan will pay .41% for monthly mortgage insurance. A borrower with a 620 score will pay 1.10% for the same kind of loan.
Your other debt service will also determine how much you qualify for because the lender (actually, Fannie and Freddie, one of whom will almost certainly buy the loan) will limit your total obligations to 50% of your gross monthly income.
Now that all the theory is out of the way, here are some examples, all based on a 50% DTI:
- You have 20% cash to use as a down payment, plus a bit more for closing costs. Your credit score is 740 and you owe $500 in other debt payments. You can expect a rate of about 4.875% and will qualify for a purchase of about $740,000. Your monthly payment will be $4,000 including taxes and insurance
- You have 10% cash available to put down. Other variables are the same. You’ll qualify for $640,000 with a total monthly payment of..surprise—$4,000. The reason for the difference in price is the larger loan amount and $200 a month in mortgage insurance
- You have 5% cash to put down. Now your loan is larger and the cost of mortgage insurance is higher, so your maximum is going to be $600,000.
Can you buy in the Bay Area?
There are those who have said “fugeddaboudit” about buying a home in the Bay Area. While prices in Silicon Valley have gotten, well…stratospheric the last couple of years, there are plenty of other decent areas where prices are within your reach. In Contra Costa County, nearly half the active inventory is priced below $600,000. For Alameda County, it’s about 1/3.
The Secret Sauce: Tax Credits!
There is one other thing that can help you, if you’re a first-time buyer. You qualify for that status if you have not owned your principal residence for at least three years. As a first-time buyer earning less than $125,000 (or $146,000 if your houshold is 3 or more), you qualify for Mortgage Credit Certificates (MCC). This is a little-known program that will allow you to claim 20% of the mortgage interest you pay as a tax credit—it comes off the bottom line of your taxes. Because the credit is a specific amount, we treat it as income, which will further increase the amount a buyer can qualify for. You likely qualify for a higher purchase price than the MCC maximum, but if you stay within the maximum, which is $585,700 for most of the Bay Area counties, it will save you thousands annually. You get the credit every year that you own the property and occupy it as your primary residence. You can get more information in our MCC video. Have a look!