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

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.

Meet the real estate broker’s interns: an ambitious group willing to do anything, earn nothing and wake up early on a Sunday to fluff the couch cushions at open houses.

In Manhattan, parking lots and garages are making way for all sorts of development, especially luxury condominiums.

Gray Burton lives in a 250-square-foot space he furnished with antiques he’s been collecting for years.

MacKenzie Thompson’s plan to buy a multifamily house in foreclosure did not pan out. She decided to buy a home in Westchester County.

A photogenic Westchester suburb with high-profile residents is also known for its art museum and a performing arts center.

A Ditmas Park co-op, Upper East Side co-op and an Upper West Side condo.

A 10-year-old house with six bedrooms in Montvale, N.J., and a renovated four-bedroom in Bronxville, N.Y.

Wealthy investors are wiring millions of dollars to New York to snatch up a piece of 157 West 57th Street - what will be New York City's tallest residential building, with 90 floors overlooking Central Park.

An apartment at the Trump International Hotel and Tower, opposite Central Park, was bought anonymously through a limited liability company.

The anchor of a proposed historic district will surely be a clutch of four mansions at Riverside Drive and 72nd Street.

Success in challenging property taxes means not having to put as much money aside in the escrow account.

Taking responsibility for a roof leak; a bank loan for capital repairs; lender says no to co-op sublet; next time, don’t forget the key.

Summerview Square is a town-house-style apartment project going up in Norwalk after a previous developer walked away, leaving squalor in his wake.

A drop in prices and low interest rates means many buyers on the Island can afford to wait.

In Hudson County, developers are working on several projects that would add thousands of units in waterfront communities like Hoboken, Jersey City and Weehawken.

A development in Austin, Tex., is an ambitious attempt to upend the conventions of the American subdivision.

A town house in New Orleans, a penthouse in Baltimore and a ranch house in Washington.

Housing prices continue to fall nationwide, with Atlanta earning the distinction as the weakest performer.

The financial crunch has been felt in Aruba, but not severely enough to cause large numbers of foreclosures and short sales.

A new law that allows businesses in Philadelphia’s Market East district to draw revenue from large digital signs has drawn attention from developers.

With its concentration of pharmaceutical giants and academic powerhouses, the region could be a major center for life sciences businesses, developers say.

The president of the New York Building Congress, which represents professionals in the construction industry, has been running the nonprofit association since 1994.

A frenetic little industry has taken root in New York City based on finding and publicizing the once-and-future homes of just about anyone with name recognition.

The plan for a business improvement district in SoHo would help with the trash problem, but some residents don’t want to cede more ground to tourists and real estate titans.

A Ditmas Park co-op, Upper East Side co-op and an Upper West Side condo.

A 10-year-old house with six bedrooms in Montvale, N.J., and a renovated four-bedroom in Bronxville, N.Y.

Properties in New Orleans, Baltimore and Bellevue, Wash.

You want them, you need them, and these power tools will pay for themselves.

One man’s discovery of the vast powers of the drill.

An abandoned log house with a sinister air, the Smith Mansion in Wyoming is the stuff of legend.

Chris Hacker, the chief design officer at Johnson & Johnson, shops for hot water bottles that can come out from under the covers.

Should I remove the family photos hanging on my wall before listing my apartment?

An architect and an interior designer have created an online database of hazardous building materials.

The handmade house, doughty and particular, is being celebrated in three new books.

Beginning Friday, the NoLIta store Haus Interior will host Wood Shop, a pop-up store created by David Stark.

Compare the cost of renting and buying equivalent homes.