How Much House Can You Afford?

When house shopping in the Hamptons, $400,000 is not considered to be much of a budget.

It could buy a one-bedroom, waterfront, upper-level duplex co-op in Montauk. It could also buy a two-bedroom cottage in East Hampton or Southampton, north of the highway. In Hampton Bays, that same budget stretches further and could buy a four-bedroom, 1,600-square-foot house.

Unlike most places on the planet, here in the Hamptons anything under $1 million is considered to be the low end of the market. And the trend only continues as the listing prices go up, according to Judi Desiderio, Town & Country Real Estate’s chief executive officer.

“One million dollars in Montauk is not anywhere near what you could get in East Hampton, which is not anywhere near what you could get in Southampton, and so on and so forth,” Ms. Desiderio said last week during a telephone interview from her East Hampton office. “You might turn around and choose to be in Westhampton Beach or the North Fork because there, with $1 million, you get a lot more bang for your buck.”

For many homeowners, paying in cash upfront is not an option. That’s where a mortgage lender comes in, according to Steve Boyd, senior loan officer of Americana Mortgage Group in Southampton, who aims to help score the best deal with a bank before closing on a home.

“How much house can you afford? Basically, what you need is a real good grasp of your annual income,” Mr. Boyd said last week during a telephone interview. “Someone with a W-2 is easy. Self-employed is a little tougher.”

The process begins with an interview and rounding up all key paperwork, Mr. Boyd explained, including W-2s, checking and savings account balances, stocks, bonds, 401Ks, tax returns, and credit reports.

“What I’m doing, basically, is looking at it from an underwriter’s standpoint. I used to do contract underwriting, so I know what they want to see when the file hits their desk at the bank,” he said. “The underwriter wants to see a pattern of savings.”

Next comes the math. Most important is the debt-to-income (DTI) ratio, which is the percentage of a homeowner’s monthly gross income that goes toward paying debts.

The front-end ratio, which is typically 35 to 40 percent of the gross income, goes toward housing costs, known as PITI—mortgage principal and interest, mortgage insurance premium, hazard insurance premium, property taxes and homeowners’ association dues, when applicable.

The back-end ratio includes all recurring debt payments, including PITI, as well as credit card bills, car loans, student loans, child support payments, alimony payments and legal judgments, if they apply. That number typically rests at 40, but can go as high as 50.

Using yearly figures, if the lender requires a DTI ratio of 35/40, a homeowner making $50,000 would be allowed to spend $17,500 of $20,000 of total debt payments on housing—and no more.

“The debt-income ratio can go even higher in some cases where borrowers have really excellent credit and a lot of money in the bank backing them,” Mr. Boyd said. “And nowadays, you can buy a house with as little as 3 percent down.”

Up to $625,500, prospective homeowners can close with a 3-percent down payment. Anything higher is considered a “jumbo loan,” Mr. Boyd said, and requires 20-percent down, though many of the higher-end buyers do not take out mortgages.

“Once you get properties that are $10 million, they’re not doing mortgages,” Mr. Boyd said. “I’m serious. I haven’t done one yet and I’ve been doing this 18 years. I’ve done plenty of $1.4-, $1.5-million loans. Someone who’s buying a $10-million house is savvy enough to know what they can and cannot afford. The real high end of people who are wondering what they can afford is probably $1 million.”

For a $1 million home, a buyer would need to put down $200,000—or 20 percent of the sale price—upfront, Mr. Boyd said. Taking PITI into account and no additional debt, monthly payments would work out to be approximately $4,579 for 30 years to pay off the $800,000 loan. In order to satisfy those payments, the buyer would have to make at least a $140,000 gross annual income, Mr. Boyd said.

Applying the same formula to a $400,000 loan, the mortgage payment would be $2,647 per month, for 30 years, requiring the homeowner to earn at least $72,000 per year.

“As far as figuring out what they can afford, taxes are a huge thing to take into play,” Mr. Boyd said. “Somebody might be looking at something in Riverhead or Flanders for $200,000 and have taxes that are five or six thousand, but can find something in East Quogue for $75,000 more in house and still afford it because the taxes are less. Generally, the taxes are much lower as you go further east.”

For the $400,000 listings earlier referenced, the annual property taxes on the two-bedroom cottages in East Hampton and Southampton are $4,578 and $2,935, respectively. But in Hampton Bays, the taxes are $6,436 for the four-bedroom home.

“People say, ‘Oh wow, I can get a loan for 3 percent down,’ but really, they need to take taxes into account, and closing costs, and they need to have a couple bucks of savings still in the bank,” Mr. Boyd said. “Two months of mortgage payments in the bank, post-closing. By getting professionally evaluated, it gives you a barometer of what can be afforded.”