One of the big questions when you are going to buy a house, is can I afford it? Well, I should say can I afford the house I really want. There has to be a guideline. Mortgage companies have rules they follow to see how much house you can afford. It isn’t hard to calculate so here are those rules. Maybe this will help you realize how much house you can afford and if it is reasonable to buy in the area you want. I looked up the “rule of thumb” to find out the formula brokers use.
The rules of home affordability. Mortgage lenders use something called qualification ratios to determine how much they will lend you. Although each lender uses slightly different ratios, most are within the same range. Some lenders will lend a bit more, some a bit less. The average qualification ratios will help you 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. This seems reasonable to me, but some people may think that is low. You don’t want to be house poor, which is a phrase to describe someone that can afford their house payment but can’t do much else.
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, association fees (if applicable), and property taxes) should not exceed 32% of your gross monthly income. That means, for the same couple, their total monthly housing payment cannot be more than $2,133 per month.
Your maximum monthly debt payments (rule of 40): Finally, your total debt payments, including your housing payment, your auto loan or student loan payments, and minimum credit card payments should not exceed 40 percent of your gross monthly income. In the above example, the couple with $80k income could not have total monthly debt payments exceeding $2,667. If, say, they paid $500 per month in other debt (e.g. car payments, credit cards, or student loans), their monthly mortgage payment would be capped at $2,167. 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 in mortgage payments. In many cases, banks won’t approve a mortgage until you reduce or eliminate some or all other debt. Any of us who have bought a home learned this very quickly. If you’re on the verge of shopping for a home, or starting the process, I highly suggest eliminating some of the debt you already have.
Like I always suggest, the best thing to do every time is to talk to a pro. A pro with a good reputation is your best bet. Even if you aren’t ready now, a good agent can let you know what steps you should start taking in order to be ready as soon as possible. Since Realtors deal with this issue daily, they offer great advice that can fit your personal needs and help you boost your credit to where it needs to be in order to get a great interest rate. Since this a major purchase, it is best to do it right the first time.