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How to Prequalify a Buyer When You Sell Your Home "By Owner"
By Bruce Andrews
One question many "for sale by owner" sellers ask is "how can I determine if a
potential buyer can afford to buy my house?" In the real estate industry this is
referred to as "pre-qualifying" a buyer. You might think this is a complex process
but in reality it is actually quite simple and only involves a little math.
Before we get to the math there are a few terms you should understand. The first
is PITI which is nothing more than an abbreviation for "principal, interest, taxes and
insurance. This figure represents the MONTHLY cost of the mortgage payment of
principal and interest plus the monthly cost of property taxes and homeowners
insurance. The second term is "RATIO". The ratio is a number that most banks
use as an indicator of how much of a buyers monthly GROSS income they could
afford to spend on PITI. Still with me? Most banks use a ratio of 28% without
considering any other debts (credit cards, car payments etc.). This ratio is
sometimes referred to as the "front end ratio". When you take into consideration
other monthly debt, a ratio of 36-40% is considered acceptable. This is referred to
as the "back end ratio".
Now for the formulas:
The front-end ratio is calculated simply by dividing PITI by the gross monthly
income. Back end ratio is calculated by dividing PITI+DEBT by the gross monthly
income.
Let see the formula in action:
Fred wants to buy your house. Fred earns $50,000.00 per year. We need to
know Fred's gross MONTHLY income so we divide $50,000.00 by 12 and we get
$4,166.66. If we know that Fred can safely afford 28% of this figure we multiply
$4,166.66 X .28 to get $1,166.66. That's it! Now we know how much Fred can
afford to pay per month for PITI.
At this point we have half of the information we need to determine whether or not
Fred can buy our house. Next we need to know just how much the PITI payment is
going to be for our house.
We need four pieces of information to determine PITI:
1) Sales Price (Our example is 100,000.00)
From the sales price we subtract the down payment to determine how much Fred
needs to borrow. This result brings us to another term you might run across.
Loan to Value Ratio or LTV. Eg: Sale price $100,000 and down payment of 5% =
LTV ration of 95%. Said another way, the loan is 95% of the value of the property.
2) Mortgage amount (principal + interest).
The mortgage amount is generally the sales price less the down payment. There
are three factors in determining how much the P&I (principal & interest) portion of
the payment will be. You need to know 1) loan amount; 2) interest rate; 3) Term of
the loan in years. With these three figures you can find a mortgage payment
calculator just about anywhere on the internet to calculate the mortgage payment,
but remember you still need to add in the monthly portion of annual property taxes
and the monthly portion of hazard insurance (property insurance). For our
example, with 5% down Fred would need to borrow $95,000.00. We will use an
interest rate of 6% and a term of 30 years.
3) Annual taxes (Our example is $2,400.00)/12=$200.00 per month
Divide the annual taxes by 12 to come up with the monthly portion of the property
taxes.
4) Annual hazard insurance (Our example is $600.00)/12=$50.00 per month
Divide the annual hazard insurance by 12 to come up with the monthly portion of
the property insurance.
Now, let's put it all together. A mortgage of $95,000 at 6% for 30 years would
produce a monthly P&I payment of $569.57 per month. This figure was produced
by our payment calculator. Add in taxes of $200.00 per month and add in
insurance of $50.00 per month and the PITI necessary to purchase our house
equals $819.57.
Putting it all together
From our calculations above we know that our buyer Fred can afford PITI up to
$1,166.66 per month. We know that the PITI needed to purchase our house is
$819.57. With this information we now know that Fred DOES qualify to purchase
our house!
Of course, there are other requirements to qualify for a loan including a good
credit rating and a job with at least two years consecutive employment. More
about that is our next issue.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Bruce Andrews has been in the real estate business for over 20 years. He has
experience in real estate investing as well as practicing real estate as a broker for
several years. He is currently President of Fifty States Realty,
www.fiftystatesfsbo.com a national "for sale by owner" website.
By Bruce Andrews
One question many "for sale by owner" sellers ask is "how can I determine if a
potential buyer can afford to buy my house?" In the real estate industry this is
referred to as "pre-qualifying" a buyer. You might think this is a complex process
but in reality it is actually quite simple and only involves a little math.
Before we get to the math there are a few terms you should understand. The first
is PITI which is nothing more than an abbreviation for "principal, interest, taxes and
insurance. This figure represents the MONTHLY cost of the mortgage payment of
principal and interest plus the monthly cost of property taxes and homeowners
insurance. The second term is "RATIO". The ratio is a number that most banks
use as an indicator of how much of a buyers monthly GROSS income they could
afford to spend on PITI. Still with me? Most banks use a ratio of 28% without
considering any other debts (credit cards, car payments etc.). This ratio is
sometimes referred to as the "front end ratio". When you take into consideration
other monthly debt, a ratio of 36-40% is considered acceptable. This is referred to
as the "back end ratio".
Now for the formulas:
The front-end ratio is calculated simply by dividing PITI by the gross monthly
income. Back end ratio is calculated by dividing PITI+DEBT by the gross monthly
income.
Let see the formula in action:
Fred wants to buy your house. Fred earns $50,000.00 per year. We need to
know Fred's gross MONTHLY income so we divide $50,000.00 by 12 and we get
$4,166.66. If we know that Fred can safely afford 28% of this figure we multiply
$4,166.66 X .28 to get $1,166.66. That's it! Now we know how much Fred can
afford to pay per month for PITI.
At this point we have half of the information we need to determine whether or not
Fred can buy our house. Next we need to know just how much the PITI payment is
going to be for our house.
We need four pieces of information to determine PITI:
1) Sales Price (Our example is 100,000.00)
From the sales price we subtract the down payment to determine how much Fred
needs to borrow. This result brings us to another term you might run across.
Loan to Value Ratio or LTV. Eg: Sale price $100,000 and down payment of 5% =
LTV ration of 95%. Said another way, the loan is 95% of the value of the property.
2) Mortgage amount (principal + interest).
The mortgage amount is generally the sales price less the down payment. There
are three factors in determining how much the P&I (principal & interest) portion of
the payment will be. You need to know 1) loan amount; 2) interest rate; 3) Term of
the loan in years. With these three figures you can find a mortgage payment
calculator just about anywhere on the internet to calculate the mortgage payment,
but remember you still need to add in the monthly portion of annual property taxes
and the monthly portion of hazard insurance (property insurance). For our
example, with 5% down Fred would need to borrow $95,000.00. We will use an
interest rate of 6% and a term of 30 years.
3) Annual taxes (Our example is $2,400.00)/12=$200.00 per month
Divide the annual taxes by 12 to come up with the monthly portion of the property
taxes.
4) Annual hazard insurance (Our example is $600.00)/12=$50.00 per month
Divide the annual hazard insurance by 12 to come up with the monthly portion of
the property insurance.
Now, let's put it all together. A mortgage of $95,000 at 6% for 30 years would
produce a monthly P&I payment of $569.57 per month. This figure was produced
by our payment calculator. Add in taxes of $200.00 per month and add in
insurance of $50.00 per month and the PITI necessary to purchase our house
equals $819.57.
Putting it all together
From our calculations above we know that our buyer Fred can afford PITI up to
$1,166.66 per month. We know that the PITI needed to purchase our house is
$819.57. With this information we now know that Fred DOES qualify to purchase
our house!
Of course, there are other requirements to qualify for a loan including a good
credit rating and a job with at least two years consecutive employment. More
about that is our next issue.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Bruce Andrews has been in the real estate business for over 20 years. He has
experience in real estate investing as well as practicing real estate as a broker for
several years. He is currently President of Fifty States Realty,
www.fiftystatesfsbo.com a national "for sale by owner" website.
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