How Much Home Can You Afford?

How Much Home Can You Afford?

Do you know how much home you can actually afford? No, I am not asking how much you got pre-qualified for. I am asking, do you know if this new mortgage payment will fit comfortably within your lifestyle without putting any financial plans on hold?

Let’s dive deeper and get more familiar with your budget and more comfortable with buying that new home.

Determine Your Affordability 
Your affordability is how a lender will determine the amount they are willing to loan you, which will be based on your income, your debts and the lender’s guidelines.

To determine your affordability, the first step is to calculate your gross monthly income. Gather your pay stubs and any other documentation to see how much you make before taxes are deducted. Record your gross monthly income, include all of the money you get each month, like pay from your job and your spouse’s job, occasional work, child support, alimony, retirement benefits, disability payments, government assistance, etc.

Here are some ways to calculate your gross monthly income based on how you are paid:

Hourly: (gross pay) x (hours you work in one week) x 52 weeks/ 12 months = $
Weekly: (gross pay) x 52 weeks/ 12 months = $
Bi-weekly: (gross pay) x 26 (twice weekly)/ 12 months = $
Twice monthly: (gross pay) x 24 (12 months x 2)/ 12 months = $
Monthly: Gross pay =
Non-regular pay: Last year’s gross pay/ 12 (months) = $
Other gross monthly income: $
Gross monthly income from all other borrowers: $
Total gross monthly income: $

Here is a worksheet where you can input your gross income, net income, and expenses and see your ratio.

Free Budget Spreadsheet

Next you will need to figure out your total monthly debt payments.

Lenders set limits on how much your payments can be each month. To do this, they use standard math formulas – called the housing ratio and debt-to-income ratio – which are calculated using your income and debt amounts.

  • Housing Ratio is used to determine how much of your gross monthly income can be used to make the monthly mortgage payment (PITI). Generally, the housing ratio is between 25-33% of your gross monthly income.

Gross monthly income x housing ratio (%) = maximum house payment allowed

$4,000 x 33% = $1,320

  • Debt-to-income Ratio (also called the back-end ratio) is used to determine how much of your gross monthly income can be used to make the monthly mortgage payment plus all other existing debt payments, like car loans or credit cards. This ratio is generally between 36-41% of your gross monthly income.

Gross monthly income x debt-to-income ratio (%) = maximum payment allowed for housing + existing debts

$4,000 x 38% = $1,520


Of course, you also want to look at your income and expenses. Is there enough of a difference between what you earn and what you owe that you can afford a house payment? The bottom line is: the more you owe on other things, the less you will have to buy a house. Generally, people who have good credit, a steady income and low debt can afford to buy a home that is two-and-a-half to three times their annual income.

  • What house price is three times your annual income?
  • Does that match up with home prices in your area?

Once you understand your affordability based on your spending plan, you can visit a lender to get pre-qualified.

During your meeting, the lender will ask questions about how much you make and how much you owe. The lender will order your credit report and calculate your ratios. Based on this information, the lender will estimate how much they are willing to lend to you, what house price you should be looking at based on the maximum loan amount allowed, how much of a down payment you will need and what the monthly payments will be. A  prequalification is not a guarantee to loan you the money. It simply gives you an estimated price range. There is a separate step, called pre-approval, where you apply for the loan, in advance of finding the home, and the lender agrees to give you a loan as long as you buy a house that is within the price limit, is worth at least as much as you borrow and is within a certain period of time.
You do not have to wait for a lender to get an estimate of how much you can qualify for. Use the worksheet (download top right) to get a rough idea of how much you can afford to borrow and the price range of the home you can buy based on your current income and debt situation. The worksheet is to give you an estimate only, as only a lender can prequalify you for a loan.
1. Refer to your gross monthly income and debt you calculated earlier in this section.
2. Select an interest rate by visiting for typical rates in your area for mortgage loans.
3. Look at the Sample Interest Factor Table to select the factor for the interest rate you selected.
After you calculate how much you can spend each month, compare that amount with what you think you can afford to pay based on your budget. Would the new mortgage payment be something you are comfortable with? Add the payment to your other monthly bills. Will you have enough extra money each month to cover your wants and needs? If the new monthly payment makes you uncomfortable, consider a less expensive house.

Now that we have looked at the numbers for prequalification, let’s input your numbers and see where you stand.  Bear in mind that any information inputted here is purely for an exercise, and any income and expenses you input will need to be verified by your lender and/or housing counselor.

As a reminder of the terms:

Gross Monthly Income is your monthly income before any taxes or deductions are taken out.

Net Monthly Income is your income after taxes and deductions are taken out.

Your Monthly Expenses are your general living expenses excluding housing, such as groceries, utility bills, etc.

Your Monthly Debts are items such as vehicle payments, credit cards, student loans, etc.

Your planned Housing Expenses are what you expect your new house to cost you per month.

Your lender uses ratios to calculate the maximum amount you can afford for housing based on your gross income. Your take-home pay is less than that because taxes and other expenses have been taken out. In addition, ratios do not include the expenses you pay every month for utilities, transportation, food, entertainment, clothing or savings. When it comes to your finances, the lender is not the expert, you are! Only take on the debt that you feel you can repay. Make your own decision about what you can afford.

What is the maximum payment you would be willing to comfortably spend?

Take your time when you work through your income and expenses. This is a very important step, and we want you to be successful in homeownership, so be sure you are comfortable with what you are willing to spend on your mortgage.

Now you know about the costs of homeownership and evaluated your financial situation as it relates to purchasing a home. This knowledge will help you qualify for a mortgage and afford your home over the long term.

Free Budget Spreadsheet