Interested in buying a home? If you are, like so many others past and present, you are probably preoccupied with figuring out how much home you need.

In this economy, you should pay equal attention to another key factor: how much home you can afford.

Arguably one of the main causes behind the housing market collapse and the ensuing waves of millions of foreclosure properties is the fact that many homeowners got themselves in over their heads by buying too much home. That could easily be repeated again if homeowners do not learn the previous lessons of the foreclosure crisis.

So, how much home can you afford? How do you determine your budget? We’ll cover a few common ways to help you find the property that matches your budget and your dreams.

Does the Annual Salary Rule Still Apply?

One common rule of thumb is that you should buy a home that costs 2.5-3 times your annual salary. For example, if you and your spouse, together, are bringing home $80,000 a year, you should look for a home in the range of $200,000 to $240,000.

During the housing crisis, people were buying homes that they could not afford – sometimes to the tune of four, five, or six times (or more) their annual salaries. When they discovered that they could not make those massive payments, they lose their homes to the foreclosure process, along with millions of others.

Even people who relied on the salary estimate did poorly. Are there better ways to assess affordability?

Examining Income-to-Debt Ratios

One way to determine how much home you can afford is to look at the amount of debt you own versus your income.

Take your gross monthly income. Lenders examine affordability by comparing this amount with the amount you would need to pay monthly for a particular property, including principal, interest, taxes, and insurance (PITI). For lenders, affordability is 33% – meaning your PITI shouldn’t be more than a third of your gross monthly income.

A back-end ratio takes the front-end ratio (described above) and adds any other recurring debt that you pay monthly (such as credit cards or car payments). This percentage should be 45% or less for most lenders.

Determining Mortgage Payments

Another method is look at monthly payments. Let’s say 33% of your gross monthly income is $1,320. At a rate of, say, 4.5%, on a $150,000 loan and 1% property tax, you would pay approximately $950 a month in PITI. (This is assuming no other debt.) At $4,000, you would have a front-end ratio limit of $1,320, so you are well below that. Your back-end ratio limit would be $1,800. Therefore, $150,000 is roughly around the right price level for you.

When asked how important the economy is to deciding one’s vote in the elections coming up this fall, an overwhelming 87% of voters polled have said it was either extremely important or very important. A higher percentage of Americans also thinks the economy is getting better – and a smaller percentage thinks it is getting worse.

What does that have to do with home prices, foreclosures, and buyers and sellers in the housing market? A lot.

As we head into the second quarter of 2012, the strength of the American economy – and how important we believe it is – is growing. Our perceptions of what is coming up this year in terms of economic performance are rising, and we are becoming more confident.

That could easily translate into more demand for housing this year – which could have a positive impact on housing prices and current housing supply.

It’s no secret that America’s residential real estate market has been a buyer’s market for years, ever since the 2007 crash and subsequent waves of foreclosures helped send millions of foreclosure listings into the market. Housing prices took a dive and cheap homes became plentiful (and still are today, especially as foreclosure rates begin to rise once more).

One must keep in mind that this is still very much a buyer’s market, and conditions are still near optimal for investors and homebuyers who want to locate the best home foreclosures and other undervalued properties.

Take mortgage loan rates, for example. They have risen from their all-time lows of the past month, but only slightly, and still remain far below what most people have on their mortgages today.

Additionally, housing prices are still well below what most people would consider fair market value. They still have room to fall further, and more foreclosure properties will enter the market this year. The farther they fall, the more upside potential there is for investors who time their purchases right and enter the buyer’s market while it is still buyer-friendly.

Throw in a growing economy – many estimate that our GDP will grow by 2.5% this year – and pent-up demand for housing over the next few years that could result in a new housing mini-boom and you can see how more people are beginning to pay attention to the economy and have confidence in its prospects.

In short, the buying market continues on as strong as ever.

Getting a pre-approval letter from your lender is highly recommended. Plus, having a letter helps you determine in advance how much home you can afford to buy, and saves you the trouble of going through the process only to find that there are problems with your application.

Why Become Pre-Approved? If You Buy Foreclosures, It’s a Must

There are plenty of advantages to becoming pre-approved. If you are buying traditional homes, for example, you can quickly show the seller that you will be able to finance the purchase of their home, which means neither of you will waste your time. Indeed, some sellers will not enter into any kind of serious discussions with prospective buyers without some proof of financing.

If you are a foreclosure investor, you will definitely need a letter or some official indication from your lender that they will more than likely approve of your purchase. At sheriff sales and courthouse auctions, even if you win a bid, you have to provide some proof of your ability to pay for the purchase in full within a certain period of time.

Proof of funds in checking and savings accounts, equity or market accounts, liquid investments, or other easily-accessible sources of money can be sufficient for cash buyers. For those who will purchase the property with a loan, a pre-approval letter is required.

Pre-Approval Versus Pre-Qualification

Note that a pre-qualification letter is not the same as a pre-approval one. A pre-qual, as they are known, just shows that you have applied for a loan and your lender has checked your credit score. From that information given, they can say you are tentatively qualified for a certain price – but know that this is far from a guarantee.

A pre-approval is more weighty; it is based off verification of your information and background, especially with supporting documentation that you have supplied. With this, you are tentatively pre-approved­ for the purchase.

To obtain a pre-approval letter, you usually need to submit two years of your tax returns with the appropriate W-2 forms, two recent bank statements, verification of other income, your most recent pay stub, and other supporting items.

Once you obtain a pre-approval letter, you can hit the market hunting for great deals at auctions.

There are roughly 10.7 million American homeowners underwater, which is about 22.8% of all residential mortgages in existence today. Those are staggering numbers for a real estate market that is supposed to be nearing a recovery – and the sheer number of people in danger of their homes becoming foreclosure properties means that something new must be done.

One possible solution being tested today could mean a new way to stop foreclosure for thousands of Americans in danger of the foreclosure process.

According to recent reports, Bank of America, one of the largest lenders in the U.S. today, is offering a “mortgage-to-lease” proposal to 1,000 BoA customers in Arizona, Nevada, and New York. The plan would allow underwater homeowners who do not qualify for other foreclosure avoidance programs (like loan modifications and short sales) to essentially trade the deed to the home to the bank for permission to rent the home for up to three years at rental rates that could be slightly below market value.

There is a possibility that homeowners will be allowed to repurchase the home, but it is not a given.

The upside potential for Bank of America and other lenders who follow this path to cutting down on foreclosure listings is that they receive income on distressed property and have someone to remain in the property so it doesn’t end up vandalized and neglected like so many other foreclosure properties on the books. Plus, with tenants, they can cut down on maintenance costs that can pile up quickly with a large portfolio of home foreclosures.

Homeowners lose the title to their homes under this proposal, which is a negative, but chances are they would’ve lost their claims to the property anyway. Under this plan, theoretically, they could avoid foreclosure and the credit score damage that comes with it and remain in their home – a psychological victory from any angle.

The main downside is that the plan doesn’t offer a clear path to eventually owning the home again. As far as we can tell, there is no provision that puts the rent paid toward the balance of a future mortgage, nor does it offer an explicit guarantee of a possible option to purchase.

This “rent-to-own” option is a major point of emphasis for homeowner advocates when it comes to a solution to the foreclosure crisis, and so far the BoA option lacks one. Still, this plan could be copied widely if successful.

When it comes to the real estate market, most people know that 2006 marked a peak for home prices that was followed by a real estate market crash. Since the crash, the real estate market has been full of foreclosure properties, which has continued to drive down home prices.

With recent economic struggles, mortgage rates have hit a record low in 2012, falling sharply from the average interest rate of 2006. However, according to Fannie Mae and Freddie Mac the average mortgage rate has exceeded 4.0% for the first time since October of 2011.

Mortgage Rates from 2005 until 2011

More often than not when we hear things like “the mortgage rate rises to 4.08%” we vaguely understand that the mortgage rate has been low and has shown signs of increases over the last week. However, it is easier to understand these recent mortgage rate trends when you take a look at mortgage rates since 2005.

In March of 2005, the average mortgage rate was 6.01%. In 2006 it was 6.32%, falling to 6.16% in March of 2007. The mortgage rate fell again in March of 2008 to 5.87% and again in 2009 to 4.98%. In March of 2010 the mortgage rate was 4.99% and fell yet again in 2011 to 4.81%.

Since 2005 the mortgage rate has been steadily declining with expected fluctuations from week to week.

Mortgage Rates from October 2011 until March 2012

Although 4.08% is definitely a lower number than the mortgage rate for March of 2011, how does it compare to the last few months? In October of 2011 the highest weekly average was 4.12% with the lowest being 3.94%. In November of 2011 the highest weekly average was 4.0% with the lowest being 3.98%. December was similar, with 3.99% being the highest rate and 3.91% being the lowest.

The same decreasing pattern has been seen for January and February. In fact, the lowest mortgage rate ever recorded is the 3.87% that was reached in February of 2012. This week, the mortgage rate is 4.08% (up from 3.92% from the previous week); however, 4.08% is still significantly lower than the 4.81% during this same time last year and is incredibly low when compared to the 2006 number.

A Sign of Recovery or Expected Fluctuations?

The increase in the mortgage rate last week from 3.92% to 4.08% is definitely more than your expected variance from week to week. However, it is still too early to tell if the increase is something significant or is merely an anomaly in the current real estate market and economy. In the end, only time will tell; for now, the market will continue to be dominated by home foreclosures and low interest rates.

The foreclosure crisis continues unabated, with more foreclosure listings headed toward the market this year. With hundreds of thousands of potential foreclosures waiting in the wings, one would think banks would be attempting to curtail the foreclosure rate as much as possible – primarily to avoid the burden of dealing with non-performing assets and an avalanche of distressed properties.

That doesn’t appear to be the case with a disturbing new trend: overvaluation.

According to a study conducted by the Federal Reserve, lenders across the country are still grossly overstating home values. The study covered sales of REO homes, or properties that made it through foreclosure auctions and are now in the sole possession of banks. The value of these homes were routinely overstated, meaning that the banks were pegging their value for more than what they really are; or, in other words, high-balling the amount of money they thought they could receive for the properties from foreclosure investors.

As a result, these properties increasingly are becoming REOs because no one is buying them at auction, which only continues to compound the foreclosure crisis. Additionally – and perhaps most importantly – placing too high a premium on these homes and overestimating their value makes the prospect of reaching loan modifications for homeowners far more difficult – resulting in fewer modifications being made and fewer homes being saved.

The reasons for this overvaluation trend range greatly. Some estimate that the valuation mechanisms lenders use in normal real estate markets are not suitable for weak markets like the one we are currently experiencing, suggesting a need for said mechanisms to be re-evaluated. Also, in many cases, banks cannot legally enter the premises of a potential home foreclosure to inspect it, meaning they are not getting an accurate picture of the home’s total value.

Not surprisingly, the Fed report suggested that lenders are doing so to “shift accounting losses from their loan portfolio to their REO portfolio” to give themselves a stronger outward appearance to regulators.

No matter what the reasons may be, though, it is important that the market develop an accurate valuation mechanism for distressed properties. Doing so would result in fewer foreclosure listings making it to market and more property-saving loan modifications being issued. Also, fewer REO properties would emerge, which would mean banks have a greater chance of selling off foreclosures and recouping their losses.

When the foreclosure fraud settlement – now called the National Mortgage Settlement Agreement – was reached in February, critics railed at its terms that did little to punish the offending lenders at the heart of a fraudulent foreclosure process or help those who are currently struggling with underwater balances.

Now, these same critics will likely approve of – at least in part – a new agreement between one major bank and the government that could actually help pre foreclosures and underwater homeowners.

Today, it was announced that Bank of America and the federal government came to agreement on a deal that would trade lesser penalties for fraud and abuse for larger reductions in the principal balances of thousands of homeowners who have loans with BoA. The bank, one of the five major lenders who signed the $25 billion National Mortgage Settlement Agreement in February, essentially promised to make deep cuts to existing mortgage balances for as many as 200,000 households.

In exchange, the bank will more than likely avoid paying $850 million in penalties assessed by the terms of the original agreement.

Under the new terms, according to Bank of America, qualified borrowers can anticipate an average reduction in the principal balance on their mortgage of over $100,000 – substantially more than the average reduction of $20,000 awarded to only an estimated 5% of all total underwater mortgages serviced by the five major lenders involved in the agreement.

Not all critics believe this is a good move. Principal reductions were originally criticized for still helping banks by making it more likely that these mortgages will pay off for the lenders, since they would be more affordable for homeowners. In this case, this move would only increase those odds and would serve as no punishment to the lenders to prevent the same behaviors that led to malpractice, malfeasance, and fraud in the first place.

Still, in light of doubts and controversies surrounding the agreement, the prospect of additional reductions to homeowners already struggling with excessive balances is undoubtedly seen as a positive, as it could prevent more foreclosure listings from hitting the market. There still remains the question of how many homeowners will be able to qualify, but those that do will more than likely receive more help now than they would under terms reached last month.

Foreclosure victims, for the most part, are made of people and institutions from all walks of life. Foreclosure, as we’ve seen, isn’t limited by race, gender, age, income level, profession, location, or any other factor.

Even churches and other houses of worship aren’t immune.

Since the beginning of the foreclosure crisis in mid-2007, foreclosure rates for churches and other houses of worship have virtually tripled, resulting in more places of worship joining the ranks of foreclosure listings across the country. Most of this massive increase in church foreclosures stems from an almost-unprecedented national wave of church construction and expansion from the mid-1990’s to 2003 (which saw $9 billion worth of construction activities for religious structures alone).

The economy was improving and church coffers were overflowing with money (particularly as a result of church investments in the hot stock market), so expansion was a natural consequence. As with virtually every other industry in the country, however, the real estate market collapse in 2007 and stock market crash in 2008 hit these properties hard.

Last year set a record with church foreclosures; 2012 could eclipse that record if the foreclosure process heats up like it appears to be doing so far. Most churches finance their construction with commercial loans that typically are due in 5 years. The problem is that banks are by and large not refinancing these loans; instead, they are pursuing foreclosure more aggressively than in years past.

Churches Switching to Credit Unions, Community Banks

Partially as a result of a heightened foreclosure process, and partially as a punishment for lenders who have contributed significantly to the poor health of the real estate market, churches are spearheading a “Move Your Money” campaign aimed at transferring balances from big banks and lenders to smaller, yet more consumer-friendly credit unions and community banks.

By late fall, 2011, churches had moved $55 million from major banks, with promises of more to come. This is a fraction of most major lenders’ overall deposits, but the signal could be a powerful one to other commercial and residential customers looking for financial institutions with a decidedly friendlier approach to doing business – at least, from one perspective.

Ultimately, such a movement – if it takes hold – could cost major lenders as much as $185 billion in deposits, with Bank of America being firmly in the crosshairs of consumers across the country. If this movement holds, that would be a substantial blow to the industry.

Housing experts have long estimated that foreclosures will rise in 2012 as a result of a massively backlogged foreclosure pipeline dating from 2010 – the year that foreclosure fraud scandals put a screeching halt to the foreclosure process for over a year.

Numbers released today suggest that estimate will hold true this year as foreclosure starts begin to rise.

The report revealed that there was a 28% increase in the number of foreclosure filings against delinquent homeowners in the month of January, moving up to 203,458 from 159,092 in December, 2011. The bulk of this increase is due to increase in foreclosure filings courtesy of Fannie Mae and Freddie Mac, who were responsible for a 60% increase in government foreclosures from December to January. All other foreclosure filings – including FHA loans, REOs, and private lenders – were only up 10%.

At first glance, it would seem that Fannie Mae and Freddie Mac, two government-sponsored enterprises that have been at the forefront of efforts from the Obama administration to curtail foreclosures, are actually doing more to contribute to the problem than solve it. But one must keep in mind that these foreclosure properties have been a long time coming and more than likely should’ve been filed years ago. Plus, properties with mortgages owned by the two GSEs, theoretically, have more of a chance of having a loan modification come through than private lenders, if only because the federal government has more direct control over the process with Fannie Mae and Freddie Mac.

Still, the spike in foreclosure filings from the two agencies will undoubtedly provide even more fuel for critics of the agencies who accuse the organizations of not doing nearly enough to curb home foreclosures.

That still doesn’t mean the news is entirely bad. Foreclosure rates actually declined in Nevada by 20% on a year-over-year basis. Nevada, the state with the highest foreclosure rate (6%) and highest default rate (16.2%), is actually in better position on paper than it was a year ago. Granted, increases in the foreclosure rate for this state and others are still expected, but parts of the country with lower-than-average rates probably will not be impacted that much – states like North and South Dakota, Wyoming, Alaska, Montana, and Nebraska.

Investors and homebuyers looking to benefit from the rise in foreclosures and fall in prices will probably have plenty of opportunities to take advantage throughout the months ahead.

The new year has witnessed a resurgence of sorts in the housing market – at least in some areas that have had price increases and decreases in foreclosure rates. But overall, 2012 is beginning to look more like a return of the foreclosure market of 2010 – with a vengeance.

The latest numbers for the last three months of 2011 released indicate that transactions involving distressed properties – including foreclosures, short sales, and bank-owned REOs – now make up 24% of all home transactions in the U.S., up noticeably from 20% in the third quarter of 2011. Since this number is from the fourth quarter of 2011, the exact percentage could be higher today.

Much of the increase is due to an increase of short sale approvals by lenders who are eager to unload underperforming mortgages from their ledgers, in the hope that by cutting their losses they will avoid the unenviable task of managing thousands of properties in a market glutted by home foreclosures that outstrip demand.

The total share of distressed properties as a percentage of total home sales is actually down by 2% from the fourth quarter of 2010, but that year saw an unprecedented number of foreclosure listings hit the market. Last year’s results were significantly lower primarily because of delays in the foreclosure process across the country as a result of foreclosure fraud scandals.

This means that hundreds of thousands of delayed foreclosures will more than likely hit the market in 2012, meaning the share of total home sales that are distressed properties will more than likely eclipse the 26% mark achieved in the fourth quarter of 2010. In fact, figures released in a few months will in all likelihood show a dramatic increase in the first three months of this year – a trend that most experts predict will continue throughout 2012.

If foreclosures and short sales continue to form a growing portion of total home sales, what impact will that have on the market as a whole? And what is the ceiling for the statistic? Chances are, housing prices will take yet another hit and could actually dip in most places after battling to a standstill over the past 6 months.

As far as a ceiling goes, experts are reluctant to put a percentage to the trend, but it is not out of question to see distressed properties sales hit the 30% mark within the next 12-18 months. That would be a historic high for the market.