How Do Mortgage Lenders Determine Loan Limits

Mortgage Lender’s Limits

Most of the mortgage lenders calculate the limit of the loan they can lend you in a similar manner. While some lenders criteria may differ, it is similar because most of them further resell these loans in the mortgage market. Mortgage loans extended by mortgage lenders are often sold to big government organizations such as Fannie Mae and Freddie Mac. These government institutions buy the loan and insure the lender against default by the borrower. Because these government organizations and institutions implement certain guidelines on the mortgage loans that qualify to be insured by them, the lenders follow a fairly common and uniform pattern for approving home loan.

At any given point of time you should keep in mind that the lenders lending limit is not the amount that you can actually afford to borrow. Your own affordability for the home loan might be and usually is very different from what the mortgage lender is willing to lend.

A mortgage lender calculates your monthly housing expenses which according to him include the following components:

  • Mortgage payment, which includes principal plus interest.
  • Property taxes.
  • Insurance.

PITI is a common term that a mortgage lender uses to signify the total housing costs for home loan borrower. PI stands for principal and interest, T for taxes and I for insurance.

A mortgage lender usually requires that your monthly housing expense does not exceed 35% of your income before tax. So if your monthly income is $6000 the lender will not allow your expected monthly expense to exceed $2100. If you are self-employed, the mortgage lender uses your after expense, net income from the bottom line of schedule C of the form 1040 that you submit to the IRS for your income returns.

It is obvious to see that this is a very simplistic kind of a calculation on the part of the mortgage lender since it ignores any other financial goal and obligations that you might have. It has no consideration for your need to save money for major events in your life such as providing for retirement, child’s college education, marriage etc.

The only other consideration that the mortgage lender makes for additional expenses is probably for your consumer debt. Consumer debt is typically what you owe on other loans such as credit cards, personal loans, automobile loans etc. Just like a mortgage lender does not want your housing expense to exceed 35% of your pretax income, he will allow about 5% of your income to go towards payment of consumer debt. If you have a high balance on your credit card or any other form of consumer debt, it is an extremely good idea to pay off this debt before you apply for a mortgage loan.

Lenders look at this financial liability as a direct factor that affects your ability to make payments on the mortgage loan in the future. Running high consumer debt is seen as a risk factor which may result in the borrower defaulting on the home loan in the future.

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