Many consumers are shaking off the real estate market hangover and going back into buying mode in hopes of taking advantage of the lower interest rates and lower home prices which have been left in the wake.  As you re-enter the home buying realm in 2012, you will be wondering “how much of a house can I afford” and there are several things that you should know about today’s newly reformed lending environment.

1. If you’re buying a home for investment, conventional lenders now require 25% downpayment for investment property purchases.  If you want to purchase an investment property with a lower downpayment, you will need to seek a private lender (which will have a much higher interest rate than with conventional financing).

2. The market for 2^nd loans dried up several years ago with the collapse of IndyMac and Countrywide.  2^nd loans were used to finance all or part of the 20% downpayment required by conventional Primary lenders, allowing buyers to obtain a conventional Primary loan with little to no money down.  Now that the secondary mortgage market has gone away, you will need at least a 20% downpayment if you want a conventional loan.  Otherwise, you will have to go with an FHA loan.

The rate for FHA loans is the same as with Conventional loans, but you have to pay MI (Mortgage Insurance) with FHA loans when you put less than 20% down.

There are 2 layers of MI:

One is the initial (up front) MI fee of 1Pt (1% of the loan amount)

The other is the ongoing MI payment which amounts to 1.1%-1.15%/year (1.15%/year if you apply a purchase downpayment of between 3.5% and 5%, 1.1%/year if you apply a purchase downpayment of more than 5%, but still less than 20%).

The ongoing MI payment is spread out over the year as a monthly payment.

The good news is that there is enough of a rebate with FHA loans (obtained at the same rate as conventional ones) to cover the up front Mortgage Insurance.

3. There is big news on the FHA lending front regarding an increase in the cost of BOTH layers of MI. Starting April 1, 2012, the up front MI for FHA loans goes up from 1% to 1.75% of the loan amount. The annual (ongoing) MI fees change as well, climbing by 10 basis across the board (so 1.25%/year for 5% or less downpayment and 1.2%/year for great than 5% down, but less than 20%) and by an additional 25 basis points for loans between $625,500 and $729,750 (the FHA loan limit is up to $729,750 in high cost areas like Washington, DC, New York City, and many parts of California)

Let’s look at example.  Let’s say you purchase a home for $500,000 with an FHA loan with 5% down.  You will be left with a $475,000 loan.  In addition to your $2,268/month loan payment (based on 4% interest rate), you will have $495/month MI payments (based on 1.25%/year of the $475,000 loan amount, divided by 12 monthly payments)

4. If you earn money as an independent contractor (“1099 employee” from an income tax standpoint), all that the lenders care about is how much “taxable” income you have made. Also, they will count your “average” taxable income over the past 2 tax years.
For example, let’s say your gross income was $200,000 in 2011 and $150,000 in 2010.  In both tax tears, you claimed $75,000 in tax deductions (deductions for your business expenses).  That leaves you with $125,000 taxable income for 2011 and $75,000 taxable income for 2010.  The average is $100,000.  Your loan qualification will be based on $100,000/year ($8,333/month) income.  Of course, all of your debts (such as car payments, student loans, and/or mortgages against other homes you own) will subtract from that $8,333/month, leaving you with an amount known as your “expendable” monthly income.  Most lenders will not allow a loan with total monthly payments (including loan principal and interest, property taxes, insurance, and/or HOA dues) that would exceed 50% of your expendable monthly income. In other words, the maximum debt to income ratio is generally 50%.

5. You also should understand the following rules regarding buying a home again after the Short Sale or Foreclosure of a home you have owned before:
Short sale with FHA Loan: You can purchase right away with no mortgage default,

3 year wait if in default at the closing, Reduced wait if you have re-established good credit and can show extenuating circumstances
Short Sale with conventional (Fannie Mae) Loan: 2 year wait if you put 20 % down, 4 year wait if you put between 10% to 20% down, 7 year wait if you put less than 10% down, 2 year wait if you can show extenuating circumstances and put more than 10% down
Short Sale with conventional (Freddie Mac) Loan: 4 year wait before being able to get a loan, 2 year wait if you can show extenuating circumstances

Foreclosure with an FHA Loan: 3 year wait before being able to get a loan, Reduced wait if you can show extenuating circumstances and re-establishes good credit
Foreclosure with a conventional (Fannie Mae) Loan: 7 year wait from the completed foreclosure sale date, 3 year wait if you can show extenuating circumstances, Additional underwriting requirements apply for 4 years after a 3 year waiting period, 7 year wait for a 2nd home, cash out re-financing, or an investment property
Foreclosure with a conventional (Freddie Mac) Loan: 5 year wait from the completed foreclosure sale date, 3 year wait if you can show extenuating circumstances

** As a side note, a Deed In Lieu of foreclosure (an agreement with your lender to “hand over the keys” to them) follows the same guidelines as the foreclosure policy for FHA loans and for Fannie Mae and Freddie Mac loans, the same as their short sale policy.

6. If you buy a lot (a piece of land) or a property that is in such bad condition that the value is only in the land, conventional lenders will only lend you 50% of the value.

In other words, you will have to put 50% down for a Lot or a “Tear-down”.

7. Even though you can obtain a conventional mortgage with as little as 20% down, you will pay .25Pt more for your mortgage if you put less than 25% down.  All conventional lenders will automatically add .25Pt cost to your loan if you put less than 25% down.

Now that you are educated about the basic rules of our current lending environment, you should now know the answer to “how much I can afford for a house” and whether or not you’re really in a position to obtain a loan for the kind of home you want.

If so, you should know that rates have hit historical lows over the past year and the rate right now for a conventional 30-Yr fixed mortgage (with 0 Pts) is around 3.75% for a Conforming loan amount (of $417,000 or less) and around 4% (with 0 Pts) for a High Balance Conforming loan amount (between $417,001 and $625,000).  The fed announced in January that they were going to do everything in their power to keep mortgage interest rates low for the next 2 years. So with eyes wide open, happy house hunting!

George Sudol  is the Broker/Owner of Bay Area Realty Services, a successful San Francisco Bay Area residential Real Estate firm. He also owns and operates Bay Area Mortgage Alliance, a California residential mortgage lending brokerage. Please feel free to contact George or one of his loan officers for a precise mortgage calculation to see exactly how much house you can afford at today’s rates.
See more at www.ba-realtyservices.com ,
Email george@ba-realtyservices.com,
or Call George at 650-242-4079