# How Much Interest Will He Pay For Each Loan Math 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 of the questions many “for sale by owner” sellers ask is “how do I determine if a potential buyer can afford to buy my home?” In real estate, this is known as “pre-qualifying” a buyer. You might think this is a complex process, but it’s actually quite simple and just involves a little math. Before we get to the math, there are a few terms you should 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 your mortgage payment of principal and interest plus the monthly cost of property taxes and homeowners insurance. The second term is “RATIO”. The ratio is a number most banks use as an indicator of how much of the buyers monthly GROSS income they could afford to spend on PITI. Still with me? Most of banks use a ratio of 28% without taking into account any other debt. (credit cards, car payments, etc.). This ratio is sometimes called the “starting ratio”. When other monthly debts are taken into account, a ratio of 36 to 40% is considered acceptable.This is called the “fund ratio”.

Now for the formulas:

The initial ratio is calculated by simply dividing PITI by gross monthly income. The completion ratio is calculated by dividing PITI+DEBT by monthly gross income.

Let’s see the formula in action:

Fred wants to buy your house. Fred makes \$50,000.00 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 that Fred can safely afford 28% of this figure, we multiply \$4,166.66 X 0.28 to get \$1,166.66. This is! Now we 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 us a house. Next, we need to know how much the PITI payment will be for our home.

We need four pieces of information to determine the PITI:

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

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

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

The mortgage amount is generally the sales price minus the down payment. There are three factors that determine how much the PI and interest portion of the payment will be. You need to know 1) the loan amount; 2) interest rate; 3) Term of the loan in years. With these three figures, you can find a mortgage payment calculator almost anywhere on the Internet to calculate your mortgage payment, but remember that you still need to add the monthly portion of the annual property taxes and the monthly portion of risk insurance (property insurance). For our example, at 5% discount, 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 the 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 property insurance portion.

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

Putting it all together

Based on our calculations above, we know that our buyer Fred can afford PITI up to \$1,166.66 per month. We know that 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 get a loan, such as a good credit rating and a job with at least two consecutive years of employment. More on that in our next issue.

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