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If you have an FHA mortgage your mortgage insurance may never go away
While an FHA loan does not require Private Mortgage Insurance it has a thing called MI (Mortgage Insurance) which is essentially identical to PMI. Unfortunately, if you get a 30-year fixed FHA loan the MI will never drop off. And if you make just a 5% down payment or less it carries a rate of 0.85%. Of course, as your equity grows you could always refinance. Depending on your circumstances an FHA loan may be your only viable option. If this is the case, you'll just have to bear down and continue to pay that MI.
Once you have 22% equity in your house you can forget about PMI
As you make your regular mortgage payments you will build equity in your home. Or you may see an increase in your home’s value. If you were to get a reappraisal after one year you might find that you have reached the magic 22% equity. When this occurs, PMI is supposed to automatically drop off your monthly bill. A good idea is to keep track of how much equity you have in your home as you might want to refinance when you reach 20%.
You can make your PMI payment several different ways
The standard way to pay for Private Mortgage Insurance is to have it included in your monthly mortgage payment. However, there are lenders that will wrap your monthly PMI payments into a slightly higher interest rate. This can be something of an advantage since interest mortgage rate is generally tax deductible.
If you pay your entire PMI upfront in one lump sum, there are lenders that will give you a discount. While that might seem enticing, you would be wasting money if you decide to sell the house before reaching 22% in equity. One mortgage expert says there is one advantage to putting less down and paying PMI. This would allow you to keep the cash that didn’t go into your down payment so it would be available in the event of an emergency. However, the truth is that your goal should be to build equity in your home and get ride of those irksome PMI payments for once and for all.
Determining how much of a house you can afford
Regardless of the type of mortgage you’ll be getting and whether he'll be paying PMI is important to buy a home with a mortgage you can afford. While interest rates have been dropping the prices of houses in many areas have been increasing –and in some cases dramatically. A general rule of thumb is that you should be able to afford a mortgage on a house that's 2 to 2.5 times your gross salary (not take-home salary). So if you're gross salary was $100,000 you should be able to afford – at least in theory – a mortgage on a home valued at $200,000 to $250,000.
Of course, this is just a general guideline. There are several other things that are important for you to know. First, you need to have a good understanding of what your lender thinks you can afford. Lenders use complex formulas to determine how much of a mortgage you could handle, plus there are new rules about mortgage lending. If possible, you should try to determine from your lender how large a mortgage it thinks you could carry comfortably. Second, it's important for you to consider your personal preferences as well as your finances to make sure you're buying a home you can live in comfortably for many years to come.
For a more detailed answer to the question of how much house you could afford be sure to watch this short video.
How lenders determine how much of a mortgage you can afford
Finally, lenders use two ratios in determining how much of a mortgage you can afford. The first is called your front-end ratio or what percentage of your annual gross income will be dedicated towards paying your mortgage each month. Your mortgage payment consists of four components – payment, interest, taxes, and insurance (PITI. most lenders believe a borrower’s PITI should not exceed 28% of their annual gross income although some will go as high as 30% or even 40%.
The second way lenders evaluate you is based on your debt-to-income ratio. This is called the backend ratio. It calculates the amount of your gross income that would be required to cover your debts – Including your mortgage payment, child support, auto loan(s) and your credit card payments. Most lenders believe this ratio should not exceed 36% of your gross income — at least not if you hope to buy your dream home.