How to Figure Out How Much You Can Afford to Spend on a House

You must budget carefully when buying a home.

When you look to purchase a house, you need to determine how much you can afford to spend on the monthly mortgage payment and how much a bank will lend to you. Banks look at two ratios, one comparing your monthly mortgage expenses to your pretax income; one comparing your total debt payments to your pretax income. When calculating the costs of your monthly mortgage, remember to include the costs of private mortgage insurance, homeowners insurance and real estate taxes.

Things You'll Need

• Calculator

Instructions

1. Consult your financial records to determine your pretax income.

2. Multiply your pretax income by 0.28 to calculate your maximum mortgage expenses per month. The 0.28 represents maximum percentage for the front-end ratio, which is the percentage of your monthly income that goes toward mortgage expenses. Most lenders cap this at 28 percent. For example, if you have a monthly pretax income of $3,700, you would multiply 0.28 by $3,700 to get $1,036.

3. Multiply your pretax income by 0.36 to calculate the maximum you can spend on your total debt payments. For example, if your pretax income is $3,700, the maximum most lenders will allow you to spend on all debt payments, including your mortgage, would be $1,332.

4. Subtract any debt payments you have to make, such as student loan payments or car payments, from the total debt payments allotment in step 3. Continuing the example, if you had a $200 car payment, you would subtract that amount from $1,332 to get $1,132.

5. Use the smaller of the results from steps 2 and 4 to determine how much you can afford for your mortgage. Finishing this example, you would see that $1,036 is less than $1,132, so the maximum you could afford to spend on your mortgage would be $1,036.

Tips & Warnings

• Your lender may be willing to use higher percentages than 28 percent and 36 percent. If so, substitute those values instead of 0.28 and 0.36. However, in order to qualify for higher ratios, you will usually need a stellar credit application or pay a higher interest rate.

References

• Bankrate: How Much House Can You Buy?
• Investopedia: Mortgages: How Much Can You Afford?