Do You Need Math For Real Estate latest 2023

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

One of the questions many “for sale by owner” sellers have is “how do I determine if a potential buyer can afford to buy my home?” In the real estate sector, we speak of “pre-qualification” of a buyer. You may think this is a complex process, but in reality, it is quite simple and only involves a bit of math. Before we get to the calculations, there are a few terms you need to 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 home insurance. The second term is “RATIO”. The ratio is a number that most banks use as an indicator of a buyer’s GROSS monthly income that they can afford to spend on PITI. Always with me ? Most banks use a ratio of 28% without considering other debts. (credit cards, car payments, etc.). This ratio is sometimes referred to as the “initial ratio”. When you take into consideration other monthly debts, a ratio of 36-40% is considered acceptable. This is called the “final report”.

Now for the formulas:

The frontal ratio is calculated simply by dividing the PITI by the gross monthly income. The final 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 $50,000.00 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 that figure, we multiply $4,166.66 X 0.28 to get $1,166.66. That’s it! We now know how much Fred can afford to pay per month for PITI.

At this point, we have half 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 going to be for our house.

We need four pieces of information to determine the PITI:

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

From the sale price, we subtract the down payment to determine how much Fred needs to borrow. This result brings us to another term you might come across. Loan-to-value ratio or LTV. For example: $100,000 sale price and 5% down payment = 95% LTV ration. In other words, the loan is 95% of the value of the property.

2) Amount of the mortgage (capital + interest).

The amount of the mortgage is generally the sale price minus the down payment. There are three factors to determine the amount of the PI and interest portion) of the payment. You need to know 1) the amount of the loan; 2) interest rate; 3) Duration of the loan in years. With those three numbers, you can find a mortgage payment calculator just about anywhere on the internet to calculate the mortgage payment, but remember that you still need to add the monthly portion of annual property taxes and the monthly portion of risk insurance (property insurance). For our example, with a 5% down payment, 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 get the monthly portion of property taxes.

4) Annual risk insurance (Our example is $600.00)/12 = $50.00 per month

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

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

put it all together

From our calculations above, we know that our buyer Fred can afford a PITI of up to $1,166.66 per month. We know that the PITI needed to buy our house is $819.57. Thanks to this information, we now know that Fred qualifies to buy our house!

Of course, there are other requirements to qualify for a loan, including a good credit score and employment with at least two consecutive years of employment. More on this in our next issue.

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