How Lenders Determine Your Maximum Mortgage

By Sheryl Landrum
Home Worth Columnist

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Lenders do not pick a maximum mortgage loan amount out of thin air when you apply for a home loan. The mortgage loan they approve is dependent on many factors and the maximum loan amount is supposedly the "correct" one for you to be able to manage. This is another reason it is so important to pre-qualify for a home loan before attempting to buy a home or refinance your existing one. So, how is your maximum mortgage amount calculated?

Mortgage Loan Amounts Depend on Your Debt-to-Income Ratio

Your debt-to-income ratio (DTI) is one of the major factors when lenders decide how much to lend you, what your interest rate will be, and how much to charge you for your new home mortgage. Underwriters look at your "front-end" (or "top-end") ratio and your "back-end" (or "bottom-end") ratio. The front-end ratio is your new mortgage payment (principal, interest, property taxes, and insurance, plus other items like homeowner dues if applicable) divided by your gross monthly income. So if your monthly income is $10,000 and your total house payment is $2,500, your top or front end ratio is 25%.

Add your other expenses--a couple of car payments at $400 each and a $200 in credit card payments--to your housing for a total of $3,500 a month, and you have a back or bottom end ratio of 35%. This falls within most lenders' guidelines, assuming that you have decent credit and a little money in the bank.

Playing around with different loan amounts and interest rates on a mortgage calculator can give you an idea of what mortgage amount you could safely apply for. Most calculators assume that front end ratios of up to 32% and back ratios of up to 38% are acceptable. But what happens if your ratios are too high?

Prequalifying Before Looking for a Mortgage Amount Pays Off

Your lender can help you analyze your debt in order to get your DTI into acceptable ratios for the mortgage you want or reduce the amount of mortgage money you can qualify for. When looking at your credit report you may wish to:

• Analyze any credit balances that you can pay down or off. Remember, removing a monthly debt obligation will lower your DTI. Many lenders will not consider an obligation with less than ten months to go before it's paid off.
• Analyze the accounts under your name. If you have co-signed for a family member who is making payments, ask your lender to remove this amount. Be prepared to prove that your family member is indeed making the payments by providing canceled checks, statements, or other documentation.
• Remember that ratios aren't the whole story. Lenders can "stretch" your ratios if you are likely to earn more in the future (like a recent med school grad), have excellent credit, or have demonstrated the ability to handle higher payments (for example if your new mortgage payment would be lower than your current rent).

Remember, the lower your DTI, the more appealing you are to a lender. Being an appealing borrower generally translates into lower interest rates and lower costs as well.

About the Author
Sheryl Landrum is a Loan Officer in San Diego, California and a freelance writer specializing in mortgage issues.