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

One questions many "for sale by owner" sellers ask isFrom the sales price we subtract the down payment
"how can I determine if a potential buyer can afford toto determine how much Fred needs to borrow. This
buy my house?" In the real estate industry this isresult brings us to another term you might run across.
referred to as "pre-qualifying" a buyer. You might thinkLoan to Value Ratio or LTV. Eg: Sale price $100,000
this is a complex process but in reality it is actuallyand down payment of 5% = LTV ration of 95%. Said
quite simple and only involves a little math. Before weanother way, the loan is 95% of the value of the
get to the math there are a few terms you shouldproperty.
understand. The first is PITI which is nothing more than2) Mortgage amount (principal + interest).
an abbreviation for "principal, interest, taxes andThe mortgage amount is generally the sales price less
insurance. This figure represents the MONTHLY costthe down payment. There are three factors in
of the mortgage payment of principal and interest plusdetermining how much the PI& interest) portion of
the monthly cost of property taxes and homeownersthe payment will be. You need to know 1) loan amount;
insurance. The second term is "RATIO". The ratio is a2) interest rate; 3) Term of the loan in years. With
number that most banks use as an indicator of howthese three figures you can find a mortgage payment
much of a buyers monthly GROSS income they couldcalculator just about anywhere on the internet to
afford to spend on PITI. Still with me? Most banks usecalculate the mortgage payment, but remember you
a ratio of 28% without considering any other debtsstill need to add in the monthly portion of annual
(credit cards, car payments etc.). This ratio isproperty taxes and the monthly portion of hazard
sometimes referred to as the "front end ratio". Wheninsurance (property insurance). For our example, with
you take into consideration other monthly debt, a ratio5% down Fred would need to borrow $95,000.00. We
of 36-40% is considered acceptable. This is referredwill use an interest rate of 6% and a term of 30 years.
to as the "back end ratio".3) Annual taxes (Our example is $2,400.00)
Now for the formulas:12=$200.00 per month
The front-end ratio is calculated simply by dividing PITIDivide the annual taxes by 12 to come up with the
by the gross monthly income. Back end ratio ismonthly portion of the property taxes.
calculated by dividing PITI+DEBT by the gross monthly4) Annual hazard insurance (Our example is $600.00)
income.12=$50.00 per month
Let see the formula in action:Divide the annual hazard insurance by 12 to come up
Fred wants to buy your house. Fred earns $50,000.00with the monthly portion of the property insurance.
per year. We need to know Fred's gross MONTHLYNow, let's put it all together. A mortgage of $95,000 at
income so we divide $50,000.00 by 12 and we get6% for 30 years would produce a monthly PI
$4,166.66. If we know that Fred can safely afford 28%Putting it all together
of this figure we multiply $4,166.66 X .28 to getFrom our calculations above we know that our buyer
$1,166.66. That's it! Now we know how much Fred canFred can afford PITI up to $1,166.66 per month. We
afford to pay per month for PITI.know that the PITI needed to purchase our house is
At this point we have half of the information we need$819.57. With this information we now know that Fred
to determine whether or not Fred can buy our house.DOES qualify to purchase our house!
Next we need to know just how much the PITIOf course, there are other requirements to qualify for
payment is going to be for our house.a loan including a good credit rating and a job with at
We need four pieces of information to determine PITI:least two years consecutive employment. More about
1) Sales Price (Our example is 100,000.00)that is our next issue.