Reader question: “We are trying to come up with a budget for buying a house next year. We’ve hit a sticking point, in terms of affordability. How much of a mortgage loan can we afford with a combined salary of $125,000?”
I salute you for working on your budget in advance. Mortgage affordability is one of the most important concepts when buying a home. But many first-time buyers don’t give it enough consideration. Then they end up with a home loan that stretches their budget too far. They can’t afford to go out to dinner with friends. They can’t afford to take vacations. And, in many cases, they end up losing the home to foreclosure, or else having to sell it.
But all of this can be avoided.
If you understand the basic concepts of mortgage affordability, you’ll keep your housing costs within reach. This will improve your quality of life in several ways. You’ll have more income left over each month. You’ll have less stress in your life. And you’ll be able to keep your home. We can all agree that these are good things! Here’s how to figure out how much of a mortgage you can afford…
First Question: How Much Can I Afford Each Month?
This process starts with some personal and financial soul-searching. You need to ask yourself, how much can I realistically afford to pay toward my mortgage each month? Chances are, you can’t answer this question off the top of your head. And that’s okay. At this point, you just need to frame the question in your mind.
Next, get out a piece of paper and something to write with. Start writing down the different things you spend money on each month:
- car payment
- savings account contribution
- credit card payments
- any other recurring monthly expenses you have
If you’re currently paying rent, you can exclude that number. Your rent will go away if and when you buy a home. Hooray! Next, add up these monthly expenses and circle the number you come up with. That’s the total of your monthly expenses. And it will help you answer the question: How much of a mortgage loan can I afford to borrow?
So now you have your monthly expenses. You need to compare this number to the amount of money you earn each month. This is your net monthly income, after taxes — i.e., your “take home” pay. It doesn’t make sense to use your gross monthly income when measuring mortgage affordability, because much of that income is lost to taxes. Boo!
Now subtract your monthly expenses from your monthly take-home pay. This is the maximum amount you can afford to pay each month, toward a mortgage payment. This is your housing budget. It’s the most important number you’ll use during the home buying process.
Actually, I recommend keeping your mortgage payment well below this number. For example, if you subtract your monthly expenses from your net income, and you end up with $2,500 … I recommend keeping your mortgage payment below $2,000. Why? Because it’s good to have a cushion.
You don’t want to spend every extra dime you make on your mortgage payment. What would you do if you had a financial emergency, like a medical expense? You’d be cash-strapped, to say the least. So try to keep your monthly mortgage payment below the maximum allowance you came up with.
Second Question: What am I Willing to Sacrifice?
The last thing you want to do is sacrifice your quality of life, just so you can afford your mortgage payments. This defeats the purpose of buying a home in the first place. Homeownership is supposed to improve your life, not detract from it.
So when you’re done with the budgeting math, think about the changes you’ll have to make in your life. If you can keep your mortgage payment similar to your current housing expense (rent, for example), then you won’t have to make any sacrifices. This is an ideal scenario. But it doesn’t always work out that way. More often than not, people increase their housing costs when buying a house.
So now the question is, how much will you increase your monthly expense? And what will you have to sacrifice to cover those mortgage payments? If you have to sacrifice too many things that are important to you, then you’ve failed the mortgage affordability test. Even if you can afford to make the payment each month, you’ve given up too much. This is why it’s so important to account for all of your monthly expenses when you do the budgeting math we covered earlier.
Measuring Mortgage Affordability is Your Job, Not the Lender’s
Many first-time home buyers skip the budgeting process altogether. They think that the lender will tell them how much they can afford to pay each month. This is a flawed notion. The lender wants to give you the biggest loan possible with the highest interest rate. This is how they make money. Sure, they’ll run some basic formulas (like debt-to-income ratios) to keep your loan size realistic. But that’s all.
The worst thing you can do is walk into a mortgage lender’s office and say: How much of a mortgage can I afford to borrow? This is what many first-time home buyers do, and it’s always a bad idea. Here’s why. In some cases, there is a big difference between (A) the amount of money you can comfortably afford to pay each month, and (B) the maximum amount the lender is willing to give you.
Mortgage affordability and approval are not the same thing. It’s possible to get approved for a loan that’s too big for you — one that stretches your budget to the limit. This is the kind of home loan that leaves you cash-strapped and “house poor.” You can barely cover your mortgage payment each month, and you certainly can’t afford to do any fun stuff like dining out. That’s no way to live your life. Remember, the sacrifices need to be acceptable to you.
Mortgage affordability is your responsibility — not the lender’s. After all, they can sell your loan into the secondary mortgage market through Freddie Mac or Fannie Mae. I can’t stress this point enough. Your lender does not care about your long-term financial success. They’re probably going to sell your loan into the secondary mortgage market, anyway. So what do they care if you default on the loan down the road? They don’t. This is one of the dirty little “secrets” of the lending industry. You need to be your own advocate. You need to look out for your own financial success.
Recap: Before you start talking to lenders, you need to establish a basic home-buying budget for yourself. You need to add up your total amount of your monthly expenses, and then determine a maximum spending limit with those expenses in mind. You should do these things before you apply for a loan.
Don’t Rely on Mortgage Calculators
Mortgage affordability calculators are handy tools. You can enter your gross annual income, down payment and debt levels, and the calculator will then tell you the maximum amount most mortgage lenders will give you. But this is not how you should determine how much of a home loan you can afford. These calculators approach things from the lender’s perspective, not yours.
Here’s an explanation taken from the mortgage affordability calculator on CNN’s website: “To arrive at an ‘affordable’ home price, we followed the guidelines of most lenders.” These guidelines include (A) total debt-to-income ratios and (B) housing payment-to-income ratios. But these ratios are created by lenders. They don’t take into account your particular financial situation. CNN even put the word “affordable” in quotes, to point out this very fact. The calculator tells you what’s an affordable mortgage from the lender’s perspective. But this number might be more than you’re actually willing or able to spend.
Here’s what it all boils down to. A mortgage affordability calculator can give you a rough idea what lenders might be willing to give you. But they’re not a true measurement of what you can comfortably afford. You need to establish your monthly housing budget for yourself, as we discussed earlier.
This article answers the question: How much mortgage can I afford to take on? As you can see, this is a question that only you can answer. Nobody else can do it for you — least of all a mortgage lender. If you’d like to learn more about this topic, you can use the search tool located at the top of this website.
Brandon Cornett is a veteran real estate market analyst, reporter, and creator of the Home Buying Institute. He has been covering the U.S. real estate market for more than 15 years. About the author