The smart way to shop for your new home! Learn how to calculate how much house you can afford before hitting that open house or applying for a mortgage.
If you’re ready to buy a new home, especially if it’s your first home, you are probably asking yourself- “How much house can I afford?” This probably the question at the top of your list.
I always suggest new buyers think of this question from two different perspectives.
The 1st is simple, “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.
The 2nd perspective is a bit more subjective. “How much home do you really need?” Keep in mind that just because you qualify for a certain mortgage amount, doesn’t mean that you should max your home purchase at that amount.
Now, let’s start figuring out some numbers…
The 28% Front-End Ratio
When you submit your home loan application, the lender 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, your lender 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.
As a basic guide– Let’s say that your income is $10,000 each month. Subject to other factors, you would qualify for a home loan as long as your monthly housing expenses doesn’t exceed $2,800 each month.
Your $2,800 monthly expenses would include your mortgage payment (principal and interest), property taxes, PMI* (if required), and homeowners insurance.
*More on PMI later.
On to the next hurdle…
The 36% Rule
Ok, even if your housing-expense-to-income ratio is 28% or less, you have one more hurdle to clear: the debt-to-income ratio.
This is referred to as the back-end ratio. The back-end ratio 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 an entire view of your financial situation. With these two concepts 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.
Lenders 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 three different incomes:
| Gross Income | 28% of Monthly Gross Income | 36% of Monthly Gross Income |
|---|---|---|
| $80,000 | $1,867 | $2,400 |
| $100,00 | $2,333 | $3,000 |
| $150,000 | $3,500 | $4,500 |
Here’s some examples…
Let’s consider someone with a 150K annual income.
Here are a few condo examples using $400/month in HOA dues and a 3.875% interest rate conventional loan.
450K Condo
| Principal and Interest | $2,052.58 |
| Mortgage Insurance | $189.15 |
| Homeowners Insurance | $40.00 |
| Estimated Property Taxes | $318.75 |
| Condo HOA Dues | $400.00 |
| Total Monthly Payment | $3,000.48 |
500K Condo
| Principal and Interest | $2,280.65 |
| Mortgage Insurance | $210.17 |
| Homeowners Insurance | $45.00 |
| Estimated Property Taxes | $354.17 |
| Condo HOA Dues | $400.00 |
| Total Monthly Payment | $3,289.98 |
525K Condo
| Principal and Interest | $2,394.68 |
| Mortgage Insurance | $220.68 |
| Homeowners Insurance | $50.00 |
| Estimated Property Taxes | $371.88 |
| Condo HOA Dues | $400.00 |
| Total Monthly Payment | $3,437.23 |
Here’s a row house example using a 2.875% interest rate conventional loan.
500K Row House
| Principal and Interest | $2,138.73 |
| Mortgage Insurance | $358.86 |
| Homeowners Insurance | $95.00 |
| Estimated Property Taxes | $371.88 |
| Total Monthly Payment | $2,964.47 |
Questions
We will be happy to answer any questions and help you get started.
