It makes sense, too, as this is a pretty significant concern. Ensuring that you can not only qualify for a certain level of mortgage but then continue making those payments for as many as 30 years is a tall order. Luckily, we have a few tips for calculating your own mortgage sweet spot.
Table of Contents:
Needs vs Wants
If you’re considering buying a home, it helps to have an idea of how much you can afford. This will tell you the dollar amount that you need to stay below in order to make a financially wise home-buying decision.
It’s very important to think of this question from two different perspectives, though.
The first is simply: for how high of a mortgage will you qualify? The answer to this question depends on a lot of factors. Some of these factors include your income, existing debts, interest rates, credit history, and your credit score.
(In a moment, we’ll look at several calculations that most lenders use to evaluate mortgage applicants. That way, you can narrow this answer down a bit before you even begin the application process.)
The second perspective is a bit more subjective: how much home do you really need? Just because you can qualify for a mortgage, doesn’t mean that you should.
Banks will qualify you for as much as they possibly can, given their existing underwriting policies. But just because the money is available doesn’t mean you should take it. This is where you need to rein in your wants, in order to make a smart mortgage decision.
Here’s a fantastic resource for you to use – a calculator that takes into account your city, debt, income and downpayment and automatically tells you how much house you can afford.
If you want to do the calculation manually, let’s look at five ways to calculate how much house you can afford, beginning with a standard rule of thumb.
1. Multiply Your Annual Income By 2.5 or 3
This was the basic rule of thumb for many years. Simply take your gross income and multiply it by 2.5 or 3, to get the maximum value of the home you can afford. For somebody making $100,000 a year, the maximum purchase price on a new home should be somewhere between $250,000 and $300,000.
Keep in mind that this is a very general rule of thumb, and there are several factors that will influence the results. For example, the lower the interest rate you can obtain, the higher the home value you can afford on the same income.
This is one reason why your credit score is so important. A good credit score of 760 or higher could net you an interest rate that is 1.5% lower than if you had a fair score of, say, 620. A 1.5% lower rate can easily translate into savings of tens of thousands of dollars over the life of a mortgage.
If you don’t know your credit score, you can get your FICO score for free from one of several credit scoring companies.
Also keep in mind that others may suggest using higher or lower multiples to determine your ideal home purchase price. I’ve seen banks recommend ratios as low as 1.5 times your salary or as high as 5 times your salary. I think that for most situations, a good starting point is 2.5 times your income.
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2. The 28% Front-End Ratio
When banks evaluate your home loan application, they will look at one very important calculation in particular. This is known as your housing-expense-to-income ratio.
Also called the front-end ratio, banks will take your projected housing expenses for the home you want to buy and divide by your total monthly income. Generally, mortgage companies are looking for a ratio of 28% or less.
For example, let’s say that your income is $10,000 a month. Judging by this, most banks would qualify you for a loan (subject to other factors, of course), so long as your total housing expenses do not exceed $2,800 each month. This means that your mortgage payment (principal and interest), property taxes, PMI (if required), and homeowner’s insurance all need to stay below this threshold.
While the 28% mortgage-to-income ratio is followed by many institutions, some will qualify a borrower with a slightly higher ratio. Again, it all depends on the lender, your credit history, and other individual factors.
Resource: 11 Home-Buying Programs for Low Income Families
3. The 36% Rule
Even if your housing-expense-to-income ratio is 28% or less, you still have one more hurdle to clear: the debt-to-income ratio.
Also referred to as the back-end ratio, this takes into account your total monthly minimum debt payments and then divides them by your gross income. This ratio is used in conjunction with the front-end ratio above, to give lenders a holistic view of your financial situation. With these two in mind, they’ll be able to make a clearer determination as to whether or not you’ll be approved for your requested mortgage loan.
All sorts of debt payments are taken into account for the back-end ratio. These include not only your projected mortgage, but also minimum credit card payments, auto loans, student loans, and any other payments on debt. Even child support payments are included.
Bankers typically are looking for a back-end ratio of no more than 36%, although some will go a bit higher than this. To relate both the 28% front-end and 36% back-end numbers, here is a chart showing the calculations for various income levels:
| Gross Income | 28% of Monthly Gross Income | 36% of Monthly Gross Income |
|---|---|---|
| $20,000 | $467 | $600 |
| $30,000 | $700 | $900 |
| $40,000 | $933 | $1,200 |
| $50,000 | $1,167 | $1,500 |
| $60,000 | $1,400 | $1,800 |
| $80,000 | $1,867 | $2,400 |
| $100,000 | $2,333 | $3,000 |
| $150,000 | $3,500 | $4,500 |
4. Special HFA Rules
An FHA mortgage has special rules set by the government. This means there is less “wiggle room” when qualifying for these loans versus conventional mortgage products.
For the mortgage payment expense-to-income ratio (front-end), the percentage cannot be greater than 29%. Since this is the government we’re talking about, you won’t be able to sweet talk your way into getting that waived for an extra percentage point or two, either. For the back-end ratio, the maximum to still qualify for an FHA loan tops out at 41%.
Note that although FHA loans are government-sponsored, you will still apply for the loans through private banks and mortgage companies. If you’d like to get see current rates, check out our mortgage rates, which are updated daily.
5. The Dave Ramsey Mortgage
Dave Ramsey takes a very conservative approach to home-buying. If you can swing it, he believes you should pay cash for a home. Of course, this is a tall order for many people who struggle to just save up enough for the down payment.
If you do have to take out a mortgage, Ramsey says you should finance your home with a 15-year mortgage (rather than a 30-year). He also says that your mortgage payments, including insurance and taxes, should be no more than 25% of your take-home pay. Lastly, he believes that you should not buy a home until you have at least a 20% down payment.
If you decide to follow Dave’s approach, simply divide the amount of down payment you have available by .20. For example, if you have $25,000 saved for a down payment, the maximum amount you could spend on a home would be $125,000 ($25,000 / .20).
Using this example, you’d finance $100,000 with a 15-year mortgage through your lender of choice. At prevailing rates, and making some assumptions about insurance and taxes, the monthly payment would be somewhere in the vicinity of $1,000.
Of course, you’ll also need to ensure that you have the income to handle the mortgage payments, especially since you’ll be paying more each month with a 15-year note than you would with a 30-year. Here is a table of your maximum monthly payment under the Dave Ramsey approach to mortgages. (I’ve assumed that the take-home pay is 75% of gross income.)
| Gross Income | Monthly Take-Home | Maximum Monthly Payment |
|---|---|---|
| $20,000 | $1,250 | $312 |
| $30,000 | $1,875 | $468 |
| $40,000 | $2,500 | $625 |
| $50,000 | $3,125 | $781 |
| $60,000 | $3,750 | $937 |
| $80,000 | $5,000 | $1,250 |
| $100,000 | $6,250 | $1,562 |
| $150,000 | $9,375 | $2,343 |
If you are a first-time home buyer, following Dave’s approach is going to be very difficult. Heck, it may even be difficult if you are buying your second or third home. We certainly could not have bought our first or second home under these conditions, but it’s still an approach to consider.
Related: Lenda offers terrific mortgage options if you live in TX, CA, CO, OR, AZ, IL, FL, MI, VA, GA, PA or WA
Next Steps
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You now know how to calculate the home that you can realistically (and responsibly) afford. Now you may have some financial plans to set in motion. Maybe you realize that you need to save up a bit more for your down payment. Or perhaps you need to adjust the home price that you’re seeking.
It’s always wise to get your credit in tip-top shape before mortgage shopping. A good credit score will help you snag the best possible interest rate available. This may take a few months (or longer!). So it’s wise to start cleaning up your report as soon as you can, if needed.
A quick way to get started on this is by signing up for Experian Boost™. This service can track your positive monthly payments and use that information to give your credit score a boost. Start now for free.
Learn More: Read our Experian Boost Review
Finally, if you are saving to buy your first home, a great tool to track your finances is Personal Capital‘s free financial dashboard. Connect your accounts and it will track your spending, saving, and even your investments.
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I would suggest deciding the highest monthly payment you are comfortable with for a 15 year mortgage, then getting a 30 year mortgage for that amount. The just make extra principal payments each month to bring your total monthly payment what you thought you could afford for the 15 yr.
This allows you pay the mortgage off in about 15 years and avoid a lot of interest, but still provides you with the flexibility in the event of a job loss, emergency, or just make a desired lifestyle change in the future.
As long as rates for the 15 year and 30 year are close this seems to be the best solution to me.
this is one of your more compex posts. i didnt think that there was this much to consider when buying a home. and this is just the finances, there are other things too like the neighbours and schools and stuff. i think i may rent a little longer 🙂
Don’t forget to factor in property taxes for your escrow account. They can be up to 30% of your monthly payments so are a big item to consider.
Your math isn’t working on some of the calculations. 28% of $50K, spread over 12 months is $1,167
Pete, thanks for letting me know.
There is more to this problem. One must take into consideration landscaping and home maintenance.While a new home will not require much maintenance or landscaping costs initially there will eventually be large expenses such as water heater malfunction, air condtioning/ furnace replacement (most units are warrantied for 10 years, major appliances, roof replacement(usuallly last 15 to 20 years. Landscape maintenance is also very costly even if you do the work yourself. I found this out recently when I had to do all these within 2 years. I had the resources to go through this huge hit financially. So saving at least 10 % of your gross income is the solutuion.(“The Richest Man in Babylon”) Al
Me and my husband filed a chapter 7, due to medical bills and a seperation. What do we have to do to get our credit in shape or what do you suggest to be able to get a home loan. Before the chapter 7 I had outstanding credit. Could you please assist me in this matter.
Good post. Too many people buy huge expensive homes while living on a tiny income. I bought a house for $350k, and I make more than $100k a year (fluctuates from year to year because I’m a professional investor).
Hi. My husband and I are looking to buy a house sometime next summer but I am concerned. I actually need some advice. I am 57 years old and unfortunately I have been unemployed for the last 3 1/2 years and still unable to find employment. My husband works full time and has a NAVY pension of about $22,000 per year with a salary of over $123,000. He works government contract and the contract expires 12/19/14 at which point he will receive a 6 month severance package of about $45,000 after taxes and he plans to take out his 401 K which will be about $90,000 once he is done with the company (my husband is 59). Anyway his credit score is better than mine because mine is only 521 as I have a collection account which is a school loan, I am paying $100/month on it but until I pay the balance in full of $3689.00 by the end of the year they will keep reporting me negative. Anyway we want to buy a new house but the price range is around $460,000. My husband wants to leave me off the mortgage because I am not working, my credit score is only 521 and the school loan that is in collections is hurting my score until we pay it off by the end of December. We had a short sale back in August of 2008 but I know that only stays on for 7 years so it won’t come off until August of 2015.
Anybody help us in reference to the loan amount and if we could get one despite my credit score? I have been paying off credit card debts now, never missing a payment. I will be paying off the school loan in December once my husband gets the money. Also, I am trying to get employment but its tough. Also the short sale won’t come off until next August 2015, should we wait until September 2015? We are planning to put down at least $60,000 on the house. Would this help with the past issues of short sale, credit problems such as settlements and missed payments due to unemployment from me and a job change for my husband as well as location change and moving? We were able to get a car loan but in my husband’s name only at 1% due to his salary being high. What are the chances of obtaining a mortgage from a bank or possibly a credit union with these kinds of credit problems in the past? Again, I know due to a lot of credit issues in the past, missed payments due to job change, and location, and unemployment, what kind of mortgage can we obtain?
Anybody help us? We want to buy a house and get a mortgage for at least 15 years.
SIGNED: Dire need!
That is an INSANE amount of money to spend on a house with your income, especially if you’re nearing retirement! The other red flag is that you also aren’t able to even put 20% down. For your own well being, I’d look for homes closer to the $300k range!
I guess I won’t be buying a house. Rents are through the roof. I cant afford to rent, I cant afford to buy and I can’t afford to move. So what do people like me do?
My wife and I just but a home for 565k with 7% down and 3.9% rate. Apr is estimated to be 4.04%. We pay about $800 a month in other debts. Is this considered ideal? Conservative? or risky? We’re in the northern virginia area.
I left out an important detail. Our household income is close to 200k. We just want to make sure we won’t go house broke and also have enough for travel and savings.
To compare, I own a house by myself that is worth around $315,000. I got a mortgage of $190,000 on it and I was only making $50k at the time. I think you are fine with your income/payment ratio
I’m currently married but looks like we will be divorcing down the road. I make 30k a year, zero debt besides the debt I have monthly for everyday expenses which gets paid off in full everytime. I have the down payment ready. Credit score which fluctuates between 814-821. Is it possible to keep my husband off the house if I live in California but want to buy in another state. Would I be able to qualify?
I have an annual income of 25,000 and monthly expenses of 550. My credit score is moving up but I am at 600 right now. This would be a first time home purchase for me. Can I even get a home loan with my numbers?