How much mortgage can I afford?

Determining how much mortgage you can afford involves assessing several financial factors including your income, expenses, down payment, and debt-to-income ratio. Here’s a breakdown of how these factors contribute to your mortgage affordability:

1. Income

Your gross monthly income (before taxes) is the starting point for calculating how much mortgage you can afford. Lenders typically use your income to determine your borrowing capacity.

2. Expenses

Your monthly expenses, including utilities, groceries, transportation, insurance, and other living costs, reduce the amount of income available for mortgage payments. It’s important to have a clear understanding of these costs to ensure you can handle the mortgage payments comfortably.

3. Down Payment

The amount you can put down upfront significantly impacts the size of the mortgage you can afford. A larger down payment reduces the loan amount and can also help you secure a better interest rate. Common down payment percentages range from 3% to 20% of the home’s purchase price.

4. Debt-to-Income Ratio (DTI)

The DTI ratio is a crucial factor that lenders use to evaluate your ability to manage monthly payments and repay debts. It’s calculated by dividing your total monthly debt payments by your gross monthly income. Lenders typically prefer a DTI ratio of 36% or lower, though some may accept higher ratios depending on other factors such as credit score and down payment.

Front-End Ratio

This ratio focuses on housing-related expenses only. It’s calculated by dividing your total monthly housing expenses (principal, interest, taxes, and insurance) by your gross monthly income. Lenders typically prefer a front-end ratio of 28% or less.

Back-End Ratio

This ratio includes all monthly debt payments, such as car loans, student loans, and credit card payments, in addition to your housing expenses. Lenders usually look for a back-end ratio of 36% or less, although some might allow up to 43%.

Example Calculation

Assuming the following:

Gross monthly income: $6,000

Monthly non-housing debts: $500

Desired down payment: 20% of the home price

Interest rate: 4%

Property taxes and insurance: $400 per month

Step 1: Calculate Maximum Monthly Housing Expense

Using the front-end ratio (28%): $\text{Maximum monthly housing expense}=0.28\times \text{Gross monthly income}$ $\text{Maximum monthly housing expense}=0.28\times 6000=\$1,680$

Step 2: Calculate Total Debt Payments

Using the back-end ratio (36%): $\text{Maximum total debt payments}=0.36\times \text{Gross monthly income}$ $\text{Maximum total debt payments}=0.36\times 6000=\$2,160$ Subtracting monthly non-housing debts: $\text{Maximum monthly housing expense}=\$2,160-\$500=\$1,660$

The lower of the two calculations ($1,680 and $1,660) suggests that you can afford a monthly housing expense of $1,660.

Step 3: Determine Mortgage Amount

Considering property taxes and insurance ($400 per month), the amount available for principal and interest is: $\$1,660-\$400=\$1,260$

Using a mortgage calculator to determine the loan amount at a 4% interest rate for a 30-year loan:

Principal and interest of $1,260 per month can support a mortgage of approximately $264,000.

Step 4: Add Down Payment

Assuming a 20% down payment: Home price=Loan amount1−Down payment percentageHome price=1−Down payment percentageLoan amount​ Home price=264,0000.80=$330,000Home price=0.80264,000​=$330,000

Conclusion

With a gross monthly income of $6,000, monthly non-housing debts of $500, and a 20% down payment, you could afford a home priced around $330,000, assuming a 4% interest rate and typical property taxes and insurance costs.

These calculations can vary based on interest rates, lender criteria, and personal financial situations, so it’s recommended to use mortgage calculators and consult with financial advisors or mortgage professionals to get a more tailored assessment.