How Much Mortgage Can You Afford?

Before you start scheduling showings or visiting open houses, make sure you have an accurate idea of your budget and how much mortgage you can afford.

Before you plan to spend the maximum amount you’ve been approved for, consider whether you can really afford the mortgage your lender offers.

According to the latest data from Trulia, the median selling price for a home is $192,000. That’s far more than most of us could afford to pay in cash, and why most of us take out a mortgage. But don’t rely on a lender to tell you how much of your monthly income you can comfortably spend on your home. They may let you borrow the maximum possible amount, but that doesn’t mean you should—or must—take them up on the offer. Crunch your own numbers first to determine how much mortgage you can afford before you start searching for homes for sale.

Determining How Much Mortgage You Can Afford

Varying property taxes, insurance rates, and lending legalities all factor in when determining how much you’ll be able to afford each month. Thorough research and careful calculations can ensure you avoid signing on the dotted line for a monthly payment that’s too high.

Calculate your true monthly cost.

If you want an in-depth look at your potential mortgage payment, you need a mortgage calculator that includes costs like homeowners insurance or property taxes. (You want more than just a sales price and loan interest rate.)

Your monthly insurance premiums and your property taxes will depend on what you buy and where you live. When determining how much of your monthly income you can spend on a mortgage payment, you need to add in both of these costs. To get an accurate estimate, call insurance providers for a quote and look up property tax rates in the specific city or county.

Know the legal limits on lenders.

According to the Mortgage Reform and Anti-Predatory Lending Act, a section of the Dodd-Frank Act of 2010, any entity lending money for a mortgage can’t underwrite the loan unless they determine that you can reasonably repay it. That determination is based on your credit, job history (and stability), and your income. By law, lenders can’t approve mortgages that would take up more than 35% of your monthly income.

And many lenders tend to stick with even more stringent requirements, limiting a mortgage payment to 28% of a borrower’s monthly income (known as the debt-to-income ratio or DTI) if a borrower’s credit scores, employment, and income aren’t solid.

Limit payments to no more than 30% of your gross monthly income.

You can also use 30% as a rule of thumb when figuring out your home-buying budget. Here’s an easy formula: Multiply your pre-tax monthly income by 30, then divide that by 100. The answer is 30% of your pre-tax monthly income. The median income in the U.S. is $55,775. If this were your income, you’d make about $4,648 per month; 30% of that comes out to about $1,394.

That means you could spend $1,394 on a mortgage, maximum. Remember, 30% is the top of the spectrum when it comes to how much of your monthly income you should spend on your mortgage. Paying less means a smaller strain on your budget.

It’s a good benchmark, but this number doesn’t necessarily take your full financial picture into consideration. Consider subtracting other essential expenses (such as child care or transportation costs) from your monthly income total. In addition, your lender will also consider student loans, a car loan, and credit card debt. If that debt that represents more than about 7% of your income, you may not qualify for a mortgage that costs 30% of your income. Your total debt-to-income ratio can’t exceed 35%, so you either need to pay off existing debts first or borrow less money to buy a home.

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