The Rules of Affordability
Mortgage lenders use something called qualification ratios to determine how much they will lend to a borrower. Although each lender uses slightly different ratios, most are within the same range. Some lenders will lend a bit more, some a bit less. We have taken average qualification ratios to come up with our three rules of home affordability.
Your Maximum Mortgage Payment (Rule of 28): The golden rule in determining how much home you can afford is that your monthly mortgage payment should not exceed 28% of your gross monthly income (your income before taxes are taken out). For example, if you and your spouse have a combined annual income of $80,000, your mortgage payment should not exceed $1,866.
Your Maximum Total Housing Payment (Rule of 32): The next rule stipulates that your total housing payments (including the mortgage, homeowner’s insurance and private mortgage insurance (PMI), homeowner association fees and property taxes) should not exceed 32% of your gross monthly income. That mean for the same couple, their total monthly housing payment cannot be more than $2,133 per month.
Your Maximum Monthly Debt Payments (Rules of 45): Finally, your total debt payments including your housing payment but also auto loan or student loan payments and minimum credit card payments should not exceed 45% of your gross monthly income. In the above example, If the couple with $80k income wanted the highest mortgage payment they could get, they could have up to $533 in other debt (car payments or credit cards).
This rule means that if you have a big car payment or a lot of credit card debt, you won’t be able to afford as much of a mortgage payment. In many cases, banks won’t approve a mortgage until you reduce or eliminate some or all other debt.
How to Calculate An Affordable Mortgage
Now that you have an idea of how much of a monthly mortgage payment you can afford, you’ll probably want to know how much house you can actually buy. Although you cannot determine an exact budget until you know what interest rate you will pay, you can estimate your budget. Assuming an average 6% (high side) interest rate on a 30-year fixed rate mortgage, your mortgage payments will be about $65 for every $10,000 borrowed.
$1,866 / $65 = 28.71
28.71 x $10,000 = $287,708 (Your Maximum Mortgage Amount)