Calculating your Home Affordability

One of the many questions people ask when you tell them you are looking to buy a home is, “What is your budget? How much are you looking to pay for a home?” Now, while that is somewhat of a personal question it is nonetheless a question you are probably asking yourself as well. “How much home can I afford?” There are a couple different ways you can approach the topic of home affordability in today’s market. Let’s take a look at the first approach.

Approach #1- Let the bank use your Debt-to-income (DTI) to determine maximum purchase price

When you go to a bank and ask them to calculate the maximum amount you can pay for a home they are not going to take into consideration what homes you have already looked at or what homes you may be interested in. Instead the bank will take your annual income and your annual debts and calculate the maximum amount you could pay on your mortgage without raising your debt-to-income ratio. Once they have found the maximum allowable payment size then they will then factor in today’s mortgage rates to come up with the maximum loan size you could borrow. The debt-to-income formula will not show you what should pay for a home but instead it will only show what you could pay without changing your debt-to-income. Your bank will check your DTI in two parts, front-end and back-end ratio.

• Front End- This compares the expected house payment to the buyers monthly income. While there is no maximum limit on the front-end-ratio, banks prefer to see that the front-end-ratio is less than 28% of the buyers monthly income. You can still be approved if the ratio is above 28% but it is not as often.
• Back End- This compares all other expenses including the house payment against the buyers monthly income. These other expense include, alimony, car loans or leases, credit card payments, and installment loan payments. Banks typically want to see that the back-end ratio is no higher than 36% of your total monthly income.

Approach #2- Make your own monthly household budget

You can either rely on the bank to tell you how much you can afford or you can work the amount you can afford into your household budget and work backwards to calculate the amount of the house you can afford. Most times, banks will approve you for your maximum amount but you need to make sure this will work for your budget. First you need to determine the monthly mortgage amount you are willing and able to pay without going over your budget. Next, using today’s mortgage rates work that figure backward to find your maximum loan size you can borrow. Here is an example, if you budget for a monthly housing payment of $2,500 with two percent annually going to taxes and insurance, assuming the current 30-year mortgage rate is 4%, the math “worked backwards” reveals a maximum home purchase price of $385,000. If staying within a specified budget is what you are needing this way is far more effective in staying within your means.

If you are asking yourself, “How much home can I afford?” Let us help you! Use our mortgage calculator to determine what you could possibly qualify for all while staying within your household budget.