How To Calculate Cost Of Goods Available For Sale Formula How to Prequalify a Buyer When You Sell Your Home "By Owner"

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How to Prequalify a Buyer When You Sell Your Home "By Owner"

One question that 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 called “pre-qualifying” the buyer. You might think this is a complicated process, but it’s actually quite simple and only involves a little math. Before you get into the math, you should understand a few terms. The first is PITI, which is nothing more than an abbreviation for “Principal, Interest, Taxes and Insurance. This number represents the monthly cost of mortgage principal and interest, plus monthly property taxes and home insurance. The second term is “RATIO.” This ratio is a number , which most banks use as an indicator of how much of a buyer’s monthly gross income they could spend on PITI. Still with me? Most banks use a ratio of 28%, not including other debt (credit cards, car payments, etc.). This ratio is sometimes called the “front ratio”. When other monthly debt is taken into account, a ratio of 36-40% is considered acceptable. This is called the “back ratio”.

Now for the formulas:

The front-end ratio is simply calculated by dividing the PITI by the monthly gross income. The back end ratio is calculated by dividing PITI+DEBT by gross monthly income.

Let’s see the formula in action:

Fred wants to buy your house. Fred earns $50,000 a year. We need to know Fred’s MONTHLY gross income, so we divide $50,000.00 by 12 and get $4,166.66. If we know Fred can afford 28% of that amount, we multiply $4,166.66 x 0.28 to get $1,166.66. That is all! Now we know how much Fred can pay for PITI per month.

We now have half of the information we need to determine whether or not Fred can buy our house. Next, we need to know how much the PITI payment is for our house.

We need four pieces of information to determine PITI:

1) Selling price (our example is 100,000.00)

We subtract the down payment from the sale price to determine how much Fred needs to borrow. This result brings us to another term you may encounter. Loan-to-value ratio or LTV. Ex: $100,000 sale price and 5% down payment = LTV ratio 95%. In other words, the loan is 95% of the value of the property.

2) Mortgage amount (principal + interest).

The mortgage amount is generally the sales price minus the down payment. There are three factors in determining the PI and interest) portion of the payment. You need to know 1) the loan amount; 2) interest rate; 3) Term of the loan in years. With these three numbers, you can find a mortgage payment calculator almost anywhere on the Internet to calculate your mortgage payment, but remember that you still need to include monthly property taxes and monthly hazard insurance (property insurance). In our example, Fred would need to borrow $95,000.00 with 5% down. We use an interest rate of 6% and a term of 30 years.

3) Annual fees (our example is $2400.00)/12=$200.00 per month

Divide the annual taxes by 12 to get the monthly portion of property taxes.

4) Annual hazard coverage ($600.00 in our example)/12=$50.00 per month

Divide the annual hazard insurance by 12 to get the monthly portion of property insurance.

Now let’s put everything together. A $95,000 mortgage at 6% for 30 years would give a monthly PI of

To put everything together

From the calculations above, we know that our buyer, Fred, can afford a PITI of up to $1,166.66 per month. We know the PITI needed to buy our house is $819.57. With this information, we now know that Fred IS qualified to buy 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 of continuous employment. More on this in our next issue.

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