How Much House Can I Afford?
It's easy to fall in love with the house of your dreams when you're house hunting. Make sure you know how much house you can afford, though, so that your dream home doesn't get crushed at the lender's office.
Most of the time, lenders talk about qualifying ratios or debt ratios. Some of these numbers may seem strange, but a few simple formulas can help you figure out how big a loan you might be able to afford. Even though this helps you figure out how much you can spend on a house, you should never plan a purchase based on these numbers alone. Think about going to a lender to get pre-approved for a loan so you know exactly how much money you can use.
Follow these steps to figure out how much you can afford:
- Now, take your gross monthly income and multiply it by 0.36. This is the amount you can spend each month on long-term costs. (Many lenders will let you pay off long-term debt that can't be paid off in 10 months with 36% of your monthly income.)
- Compare the maximum monthly housing cost from step 2 with your monthly housing cost from step 5, and choose the lower of the two. This is how much you can pay each month for principal, interest, taxes, and insurance, which is also known as PITI.
- In step 3, subtract the total of these monthly payments from your long-term monthly bills. This is your monthly rent or mortgage payment. (This number is used for the back end ratio, or debt to income ratio, to make sure that your total debt doesn't exceed 36 percent of your monthly income.)
- Add up all of your long-term monthly payments, like child support, auto loans, credit card payments, and anything else that can't be paid off in 10 months.
- Figure out how much money you make each month (before taxes).
- Divide this number by 0.28. This is the most you can spend each month on housing. (Lenders let you spend up to 28% of your gross monthly income on housing costs. This number is also called the front end ratio.)
The total amount of the loan will depend on how long the mortgage is and how much interest you pay. Talking to a lender will give you a better idea of what you can afford in the big picture. Getting pre-approved for a mortgage takes the guesswork out of figuring out a price range for a possible house and makes the process of buying a home less stressful.
