We’ve just begun 2024, and although it is winter, we are hearing from brokers that there are plenty of clients who are interested in purchasing a home. And while Orion continues to refinance the home loans of a portion of our clients, we also specialize in helping brokers with new borrowers make their way through the maze of buying a home. The size of the mortgage depends on your client’s income, debts, credit history, assets, and down payment, and brokers are in the ideal place to explain nuances to clients and add value.

“Prequalifying” a potential home buyer is important in helping them understand the basic financial situation. An old standard, the 28/36 rule, says that your client’s mortgage payment shouldn’t be more than 28 percent of their monthly gross income and 36 percent of the total debt.

We want your client to have the ability to repay the loan over time, and there are metrics to determine the prospect of that. For example, the “Debt-to-Income Ratio” is simply the total debt divided by the total income, shown as a percentage. Lenders use the ratio to help determine how much mortgage one can afford. Generally, 43 percent is the highest acceptable ratio a buyer can have and still obtain a Qualified Mortgage (a category of lower risk loans), but it cango higher for non-QM loans… but your client will pay a higher interest rate.

To coach your client in computing DTI, simply add up all their monthly debts and divide by their gross monthly income. For example, if monthly payments include an auto loan of $320, student loan of $400, credit cards of $250, and a rent payment of$1,200, that adds up to $2,170 in monthly obligations. If their gross monthly income is $7,500, you’d take $2,170 / $7,500 = 0.289, or a DTI ratio of nearly 29 percent, meaning 29 percent of gross monthly income is going toward debt repayment.

You may also explain the “28/36 Rule” which combines two ratios that lenders use to determine home affordability based on income and debt. The first number sets 28 percent of gross income as the maximum total mortgage payment, including principal, interest, taxes, and insurance. The second number sets the limit on the mortgage payment plus any other debts your client owes at no more than 36 percent of gross income.

Then there’s the “35/45 Rule” which recommends that your client spends no more than 35 percent of their gross income on the mortgage, and no more than 45 percent of their after-tax income to pay for all debt, including the mortgage. For example, if your client’s gross monthly pay is $5,000 and their take-home income is $4,000, they should spend between $1,750 ($5,000 x .35) and $1,800 ($4,000 x .45) on debt payments.

The “25 percent After-Tax Rule” recommends that your borrower spends no more than 25 percent of their after-tax income on a mortgage. If they make $4,000 monthly after taxes, you can tell them that they should spend no more than $1,000 per month on a mortgage. Because you are using a lower percentage with this method, it gives your client less spending power than the other methods above. It’s a more conservative financial choice, and would allow room in their budget if, say, they were planning to have a child or take on a new car payment after purchasing a home.

Example of the 25 percent after-tax rule: If you make $4,000 monthly after taxes, you should spend no more than $1,000 per month on your mortgage ($4,000 x .25).

Orion’s brokers know that all of these methods are merely benchmarks to help your client decide how much they can afford. You’ll also need to help them consider their monthly budget and other financial goals (saving for a wedding, buying a second car, putting aside money for their children’s college) when determining a feasible mortgage amount. Using an experienced mortgage broker can help a borrower immensely!

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