By Jack Harris, Mark Baumann and Charleen Knapp

Texas A&M University Real Estate Center

Before shopping for a home, it is a good idea to set the boundaries on what you can realistically afford. A mortgage calculator helps you figure out how much house you can buy based on current mortgage terms and your personal financial situation. Your credit history will determine how hard it will be to find a loan, as well as how much it will cost.

Most people use a mortgage loan to buy a house. The amount of money you can borrow is limited by:

• Income. You qualify for the loan if the monthly payment required is not more than a set percentage of your monthly income. The ratio depends on the lender and the type of loan you seek. Actually, you have to clear two hurdles -- one based on total income and one based on income after deducting existing long-term obligations. Income can be from any source as long as it is expected to be steady and continuing. If you are self-employed or work on commission, you may have to verify income levels with several years of tax returns.
• Cash down payment. In most cases, mortgage loans require a certain percent of the home value as a cash down payment.
• Current debts and credit rating. Lenders look for a good quality credit rating from your credit report. Existing long-term credit obligations will be deducted from your total income. These obligations may include car loans and lease payments, student loans, other mortgage loans, payments on credit card balances and alimony or child support payments.
• Home appraisal. The amount of the loan is based on a percentage of the lower of the sales price or appraised value. If the appraised value of the home is lower than the sales price, you may have to come up with a higher down payment.

Also, the type of loan used to finance the purchase can make a difference. There are two types of loans:

1. Conventional mortgages. Loans with no government insurance or guarantee are called conventional loans. In general, lenders will provide a loan equal to 80 percent or less of the home's value. If you need more financing, a private mortgage insurance (PMI) company will write a policy, for a fee, that allows you to borrow up to 95 percent of value.
2. Government-backed mortgages. These are loans with government backed insurance and guarantee. The Federal Housing Administration, a division of the U.S. Department of Housing and Urban Development, provides mortgage insurance. The borrower pays a fee, and a different set of rules apply for qualifying and deciding how large a loan you can get. Such loans are called FHA loans. If you are a military veteran, you may be eligible for a special entitlement from the Veterans Administration. This entitlement can be used like a cash down payment to get a mortgage loan that covers the entire costs of the home. These loans are called VA loans.
    

Conventional and government-backed loans differ in several key ways.

• Who makes the loan? Any lender can make conventional loans, as well as FHA and VA loans, if approved to do so by the appropriate agency. Conventional loans may be insured by private mortgage insurers. FHA loans are insured by the Federal Housing Administration. VA loans are guaranteed by the Veterans Administration.
• Amount of loan. The standard conventional loan equals no more than 80 percent of the appraised value or price of the home, whichever is less. The loan-to-value ratio can be increased up to 95 percent with private insurance. There is no absolute limit to the amount of the loan, though there are limits to the size loan that can be purchased in the secondary market.

FHA loan limits:

Note: Arizona, California, Colorado, Guam, Idaho, Illinois, Indiana, New Mexico, Nevada, Oregon, Utah, Virgin Islands, Washington, Wisconsin and Wyoming are low closing cost states. The other states have high closing costs.

In addition, there are limits to the size of loan that can be insured that are linked to median home prices in your area.

• Qualifying for the loan. Before approving a loan, lenders conduct a process called qualifying to evaluate how creditworthy you are. Basically, the lender wants the borrower to have reliable income sufficient to pay the mortgage payment without overburdening the family budget. Lenders have worked out ratios of payment to income that they consider reasonable. If you pass this test, you should have little trouble getting approved. If you don’t meet the criteria, you may still get the loan, but you will need some compensating factor, such as a long history of handling debt successfully.

There are two relevant ratios used in qualifying. The first relates monthly income to the monthly payment of principal, interest, taxes and insurance required for the applied-for loan. The second relates monthly income to not only the loan payment but any existing obligations you may have. You have to pass both tests to qualify. The following table shows how the ratios differ for different types of loans (conventional loan ratios are set by the lenders; these ratios are somewhat standardized because they are required by Fannie Mae and Freddie Mac for loans they purchase).

• What the loan costs. The primary cost of a mortgage loan is the interest charged, expressed in the interest rate on the loan. Also, there may be discount points paid at closing that raise the effective cost. If the loan is insured, there may be a premium at closing, one paid monthly, or both. Premiums for PMI loans vary from one-quarter to a full percent of the loan balance per year. The FHA charges an up-front premium that can be as low as 1.75 percent for first-time buyers taking a special homeowner's course. There may also be a monthly premium.
   

It is a good idea to find out how much you can borrow before beginning your house search.

Dr. Harris is a research economist, Baumann is an associate research social scientist and Knapp is a graduate assistant with the Real Estate Center at Texas A&M University.