How Much Home Can You Afford?

When the time is right to purchase a home, the first question you
need to be able to answer is how of a home you can afford. Knowing the
answer to this question will allow you to focus your search on homes
within the correct price range even before applying for a mortgage.

Debt-to-Income Ratio

The most important factor that lenders use as a rule of thumb for
how much you can borrow is the debt-to-income ratio. This ratio takes
into account a mortgage payment plus your other personal debt you are
carrying such as car loans, credit card debt and student loans. The
ratio is expressed in a percentage of how much of your income is being
used to make debt payments.

The typical guideline used by most lenders is a ratio of 36% as the
upper limit. Ratios above this may carry a higher interest rate or be
denied altogether. Lenders also like to see that generally no more than
28% be dedicated to all housing expenses.

Calculating Your Debt-to-Income Ratio

The first thing you need to do is determine your gross monthly
income. This is the income before taxes and other expenses are taken
out. If you are married and will be applying for the loan jointly you
should add together both incomes. Then take this number and multiply it
by 0.36. For example, if you and your spouse have a combined gross
monthly income of $7,000:

$7,000 x 0.36 = $2,520

This means that your total monthly debt payments should be no more than $2,520, mortgage payment included.

The next step is to determine your total non-mortgage debt payments
such as monthly credit card or car payments. For this example we will
assume your monthly debt payments come to $950. Computing the maximum
mortgage payment:

$2,520 - $950 = $1,570

From this example we have determined that the most home you can
reasonably afford is one with a mortgage payment of $1,590 which would
include property taxes, insurance and possibly private mortgage
insurance.

Remember, This is Only a Rule of Thumb

It is important to remember that just because the bank will lend up
to that amount doesn’t mean that is what you can truly afford. This is
simply a guideline you can use when shopping for a home so you are
concentrating on homes that are within your price range. In reality
your specific situation will dictate what type of home and mortgage
payment will be best for you.