It's easy to be tempted by homes that you can't afford, but your home loan amount will be based on your lender's review of your mortgage application. Here are a few things to consider when estimating "how much mortgage can I afford."
Monthly Income and Expenses
Establish monthly gross income (before deductions) for each borrower. If you are not paid monthly, divide your annual salary by 12 for an estimate. Add the annual incomes along with other income you want to include such as retirement or investment income. The chart below explains how to estimate various types of income.
Next, estimate your monthly expenses. Make a list of monthly expenses including student loans, credit card bills, vehicle loans and obligations such as family support payments. You'll also want to include estimates for property taxes and hazard insurance for your new home.
Income to Expense Ratios
Mortgage lenders use two qualifying ratios as part of the loan approval process. The first is a ratio of estimated monthly housing expenses (principal, interest, property taxes, HOA dues and insurance) divided by your monthly gross income. Mortgage lenders prefer that it not exceed 28-32 percent of your gross monthly income. This means if you earn $7,500 per month, you could safely buy a home costing about $2,100 per month according to this formula.
The more important calculation is called the debt-to-income (DTI) ratio, bottom ratio or back end ratio. It's your monthly housing costs PLUS other the other monthly bills you listed, divided by your gross income.
The Consumer Financial Protection Bureau established a maximum debt to income ratio of 43 percent as a general guideline for "qualified mortgages" eligible for sale to Fannie Mae and Freddie Mac, but mortgage lenders are allowed to require lower maximums for front and back end ratios and many do -- 38 to 40 percent is typical.
If, for example, you earn $7,500 per month, 38 percent of that equals $2,850. If your other monthly obligations come to $1,200, that leaves $1,650 for housing expense.
Credit Reports and Scores
In general, buyers with better credit are allowed to borrow at higher debt-to-income ratios. Make sure that your credit reports and FICO credit scores are in good shape. You can order one free copy of each credit report annually and also purchase corresponding credit scores. FICO notes that applicants with clean credit reports and higher credit scores may qualify for lower mortgage rates. It's worth your time to check your credit reports for errors that can lower your credit scores.
Requesting pre-approval for a mortgage before you shop for a home is a great way to learn how much house you can afford and helps you focus on homes within your price range. LendingTree's network of lenders provides mortgage quotes and can also pre-approve mortgage applications.
Home Affordability: Bottom Line
Finally, there are other considerations when asking "How much mortgage can I afford?" Expenses that lenders don't ordinarily consider (but that you might be paying) include payroll deductions, utilities, groceries, fuel, household maintenance, pet care, personal care, insurance, medical expenses, charitable contributions, clothing and investments. Write them down, add them to your other bills and your estimate housing expense and see if there's enough left over for you to be comfortable.
Want a really easy way to determine home affordability? Check out LendingTree's Home Affordability Calculator. It takes your information and generates results for an aggressive, moderate or conservative budget in just a few clicks.
Only you know if your near term plans include things like starting a business, having a child or retiring. Or you might have an expensive hobby which leaves less money for housing. Individual circumstances and financial priorities vary. Consider your personal comfort level first when deciding to buy and finance a home.