How Much Can You Afford?

Before you start looking for your next home it’s a good idea to find out just how much house you can afford. Lenders use several different methods to calculate how much you can afford to spend on a home.
First, of course, they will want to see your monthly budget, and will want to know your income, the nature and extent of your assets and your debts, and the size of the down payment you plan to make.

Once they have all the numbers and other information, most lenders use two ratios based on your income to determine how much they are willing to lend. The first ratio sets a limit on what they think you can spend for housing.

What does this mean? Let’s say a lender is using the 28% housing ratio. This means that your projected house costs (including mortgage payment, taxes, and insurance) should be no more than 28% of your gross monthly income. A lender using this ratio figures a family earning $2,500 a month can afford a monthly housing cost of $700.

These factors can be flexible, though. For example, a lender may be willing to make a larger loan if you are able to make a larger down payment, on the theory that, since you are putting more of your own money into your investment, you are less likely to default on the loan. Sometimes, as well, a lender will lend a larger amount for an adjustable-rate mortgage loan program. First-time homebuyers may find one of several special programs allows them to use more of their income for housing.

As a rule of thumb, buyers with good credit can qualify for a home purchase price roughly 2 ½ to 3 times their gross annual income. But a buyer’s total financial situation will sometimes raise or lower these figures. Lenders use a second ratio to compare your monthly debt obligations, including housing cost, to your income. This figure can raise or lower the amount of income a lender feels you can safely use for housing expenses.

If you want to pinpoint just how much house you can afford, have a good real estate agent help you find a lender who will pre-qualify you for a mortgage. Pre-qualifying will tell you exactly where you stand. Once you have been pre-qualified, you’re ready to begin your home search.