Affordability
Definition of "Affordability"
The definition of affordability in real estate is simply a buyer’s capacity to afford a house. Affordability is usually expressed in terms of the maximum amount a buyer will be able to pay for a house, and subsequently be approved for a loan in order to pay this amount. In real estate, this is known as the maximum affordable sale price, and it can be empirically calculated with relative ease.
To calculate the maximum affordable sales price, you’ll need to take into account three different metrics by which the maximum affordable sales price is calculated. These are the income rule, the debt rule and the cash rule. After calculating each of these numbers, affordability will be the lowest of the three. Let’s take a closer look at each of these rules in turn, and see exactly how they come into play in calculating the maximum affordable sales price.
The Income Rule in Affordability
This rule states that a borrower's monthly housing expense (MHE), which is the sum of the mortgage payment, property taxes and homeowner insurance premium, cannot exceed a percentage of the borrower's income specified by the lender. Once you’ve calculated a buyer’s MHE, you have their maximum affordable sales price according to the income rule.
The Debt Rule in Affordability
The debt rule says that the borrower's total housing expense (THE), which is the sum of the MHE plus monthly payments on existing debt, cannot exceed a percentage of the borrower's income specified by the lender. Once calculated, this number is often lower than the number that you might arrive at using the income rule, making it essential for calculating the maximum affordable sales price.
The cash rule in Affordability
The required cash rule says that the borrower must have cash sufficient to meet the down payment requirement plus other settlement costs. When the cash rule sets the limit on the maximum sale price, the borrower is said to be cash constrained. This number can be raised by lowering the down payment.
Popular Mortgage Terms
The interest rate that is fixed for some specified number of months or years at the beginning of the life of an ARM. ...
A documentation rule where the borrower discloses income and its source but the lender does not verify the amount. ...
The sum of all interest payments to date or over the life of the loan. This is an incomplete measure of the cost of credit to the borrower because it does not include upfront cash ...
Interest from the day of closing to the first day of the following month. To simplify the task of loan administration, the accounting for all home loans begins as if the loan was closed ...
On an ARM, the assumption that the value of the index to which the interest rate is tied does not change from its initial level. ...
A mortgage on which the payment rises by a constant percent for a specified number of periods, after which it becomes fully-amortizing. ...
The monthly index is a ratio of monthly interest costs to total funds, expressed as a percentage. Annualized interest, the numerator, is calculated by multiplying the deposit balances at ...
An option exercised by the borrower, at the time of the loan application or later, to 'lock in' the rates and points prevailing in the market at that time. When lenders 'lock/' they ...
Charging unwary borrowers interest rates and/or fees that are excessive relative to what the same borrowers could have found had they shopped the market. ...
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