Can I Afford a Mortgage, How Much House Can I Afford?

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Mortgage companies use a formula to help determine whether or not you can afford the home you want to purchase. That formula consists of two parts: a calculation of what’s referred to the front-end costs and a calculation of the back-end costs. Home buyers, on the other hand, often take a different approach to determining how much home they can afford.

The general rule of thumb of affordability is a mortgage that’s 2 to 2.5 times the amount of a buyer’s gross income. Under this guideline, someone grossing $75,000/year should be able to afford a mortgage of about $150,000 to $187,500.

To break it down monthly, it is said that most people can typically afford to pay 29 percent of their gross monthly income for monthly mortgage payments. For example, if you earn $50,000 annually, then your monthly income is $4,167. Twenty-nine percent of that is $1,208.

Let’s take a closer look at the different criteria considered by financial institutions and homebuyers.

Lenders understand that the amount homebuyers pay each month consists of more than repaying the principle and interest on the loan. That’s why they also factor in the monthly prorated costs of property taxes and insurance. Collective this is referred to as PITI or Principle, Interest, Taxes and Insurance. Calculated as a percentage of income, lenders feel most comfortable when PITI does not exceed 28%. However, it’s not uncommon for lenders to allow PITI as high as 40% of gross.

The back-end ratio considers a homebuyer’s stated debt at the time of application. All debt is included in this calculation including credit card debt, auto, student, mortgage and other loan payments, child support and alimony, and all other debt. Most lenders feel comfortable with a debt-to-income ratio that does not exceed 36% of gross income.

A home buyer’s down payment affects the monthly mortgage payment. Putting 20% down eliminates the need for Private Mortgage Insurance and lowers the amount a buyer has to borrow, both of which work to lower the front-end ratio. Some loan products allow less than 20% down, but understand that doing so increases a buyer’s monthly payment.

Many buyers tend to disregard these calculations, thinking that the real objective is to stretch their monthly payments as high as possible and purchase as much home as they can right now. The belief is that long term income will increase, making the mortgage more affordable. They enter into an arrangement in which they voluntarily become “house poor” meaning that after paying the mortgage, taxes, fees and costs of maintenance, there’s little money left over each month to pay for anything else.

Assuming they’re approved for a mortgage that falls outside the financial institution’s guidelines, the decision to become house poor becomes a personal one. But unfortunately, some become house poor without realizing it.

Here are some things to consider before you end up unexpectedly house poor.

First and foremost is to consider that the typical mortgage is for 30 years. So think not only about your life now but what you expect it to be like 10, 20, even 30 years from now.

Is a promotion in your future? What would you do if you were suddenly unemployed? How about children? While young, will one of the breadwinners stay home to care for the children? What about unavoidable expenses like water, electricity, cable, telephone, lawn care, and trash collection? Are you willing to alter your lifestyle to end excess spending so that you have more money to put towards your home? Will your home need new furniture, curtains, appliances, a roof or a driveway today or in the future? Remember, even new homes get old. And don’t forget to consider your opinion towards debt. If higher debt makes you uncomfortable, perhaps it should be avoided.

Buying a home is a huge decision and it’s definitely not something to rush into without first considering all of the above. Perhaps the best advice is to buy what you can afford right now so you can sleep better at night.