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

One questions 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 referred to as "pre-qualifying" a buyer.  You might think this is a complex process but in reality it is actually quite simple and only 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 the 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 that most banks use as an indicator of how much of a buyers monthly GROSS income they could afford to spend on PITI.  Still with me?  Most banks use a ratio of 28% without considering any other debts (credit cards, car payments etc.).  This ratio is sometimes referred to as the "front end ratio".  When you take into consideration other monthly debt, a ratio of 36-40% is considered acceptable. This is referred to as the "back end ratio".  

Now for the formulas:

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

Let 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 this figure we multiply $4,166.66 X .28 to get $1,166.66.  That's it! Now we know how much Fred can afford to pay per month for PITI.  

At this point we have half of the information we need to determine whether or not Fred can buy our house.  Next we need to know just how much the PITI  payment is going to be for our house.  

We need four pieces of information to determine PITI:

1) Sales Price (Our example is 100,000.00)

From the sales price we subtract the down payment to determine how much Fred needs to borrow.  This result brings us to another term you might run across.  Loan to Value Ratio or LTV.   Eg: Sale price $100,000 and down payment of 5% = LTV ration of 95%.  Said another way, the loan is 95% of the value of the property.  

2) Mortgage amount (principal + interest).

The mortgage amount is generally the sales price less the down payment.  There are three factors in determining how much the P&I (principal & interest) portion of the payment will be.  You need to know 1) loan amount; 2) interest rate; 3) Term of the loan in years.  With these three figures you can find a mortgage payment calculator just about anywhere on the internet to calculate the mortgage payment, but remember you still need to add in the monthly portion of annual property taxes and the monthly portion of hazard insurance (property insurance).  For our example, with 5% down 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 come up with the monthly portion of the property taxes.

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

Divide the annual hazard insurance by 12 to come up with the monthly portion of the property insurance.

Now, let's put it all together.  A mortgage of $95,000 at 6% for 30 years would produce a monthly P&I payment of $569.57 per month.  This figure was produced by our payment calculator.  Add in taxes of $200.00 per month and add in insurance of $50.00 per month and the PITI necessary to purchase our house equals $819.57.  

Putting it all together

From 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 purchase our house is $819.57.  With this information we now know that Fred DOES qualify to purchase 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 consecutive employment.  More about that is our next issue. 

Bruce Andrews has been in the real estate business for over 20 years.  He has experience in real estate investing as well as practicing real estate as a broker for several years.  He is currently President of Fifty States Realty, www.fiftystatesfsbo.com a national "for sale by owner" website.

Also: Joe Sebok and Kristan Cunningham design over Twitter, Facebook; TV writers Krista Vernoff and Kevin Maynard list in Los Feliz; former Robert Redford home in Malibu for sale.

Prolific songwriter and " American Idol" judge Kara DioGuardi's Spanish-style home in the Hollywood Hills is on the market at $1,649,000.

Sweeping views and passive green elements set apart the contemporary design by Hermosa Beach architect Patrick Killen.

A sweeping view of the Getty Center and the Santa Monica Mountains can be seen from a contemporary home in Bel-Air that features a passive green design.

Reduction of mortgage principal, usually considered taxable income, is expected to become more prevalent as the Obama administration and banks seek ways to prevent foreclosures.

With the Obama administration and private lenders actively considering mortgage-principal-reduction programs to help financially distressed homeowners, the Internal Revenue Service has issued an advisory to taxpayers who receive -- or seek to receive -- such assistance if it's offered.

Craftsman meets modern

In February, the number of homeowners with permanently reduced monthly payments grew to 168,708, the Obama administration reports, and 91,483 more trial modifications are approved.

The Obama administration Friday said its mortgage modification program continued to make progress, with the number of homeowners receiving permanently reduced monthly payments in February increasing by 45% to 168,708.

The average interest rate on a 30-year fixed-rate mortgage dropped to 4.95% this week from 4.97% last week, Freddie Mac said Thursday.

Some experts say the 2% drop from January stems from banks' efforts to keep owners in their homes.

The number of homes caught up in some stage of the foreclosure process in February fell 2% from the previous month to 308,524, a real estate firm will report Thursday.

The 24 buildings being offered, including two in L.A., are drawing global investors. The sale is also being criticized for the loss of long-term capital assets in favor of short-term gains.

Efforts to sell 24 state office buildings have drawn lots of interest from potential buyers -- as well as the ire of some former public officials who labored to get them built years ago in the belief that public ownership of the buildings would bring long-term financial benefits to taxpayers.

They seek to punish ex-CEO Bruce Karatz, but also to improve the record of a massive stock-options crackdown that so far has yielded few convictions.

Two months after the federal government's criminal cases against Broadcom Corp.'s top executives collapsed, the U.S. attorney's office is taking aim at another stock-options backdating target: former KB Home chief Bruce Karatz.

Depressed apartment market attracts adventurous investors

It's a cold winter for apartment investors in Los Angeles County: Rents are down, prices have fallen and vacancies are way up.