How Much Can You Afford?

The most frequent question I receive from those interested in purchasing a home is “How much can I afford”?   This post will address the simple mathematics behind qualifying so that anyone could do it on the back of an envelope.

There are two ratios that mortgage underwriters calculate to determine if a borrower can afford the mortgage debt – front and back ratios.

Front Ratio:  The front ratio is simply the total housing payment or PITI divided by the gross monthly income of the applicant.  For example, if the PITI is $2000 per month and your gross household income is $10,000 per month then $2000 / $10000 = 20%.  The industry benchmark for a front ratio is 28%.  In other words, statistics show that most people can afford to spend about one-third of their gross income on monthly payment.

Back Ratio:  The more important ratio is the back ratio which also takes into account your monthly debt.  Banks look at your major monthly debt which typically includes the following:  student loans, car payments, and minimum monthly payments on credit cards.  This total is then added to the monthly PITI and then divided by the gross monthly income.  For example, if all of your major monthly debt totals to $1000, then $2000 + $1000 = $3000 so $3,000 / $10,000 = 30%.  The ideal back ratio is 36% or less.

These ratios are flexible and vary by mortgage product.  Back ratios as high as 50% are allowable in some circumstances.

An easy way to estimate how much you can qualify for is just to multiply your household income by 3 or 4 times.  For example, if your household income is $100,000 then you should be able to qualify to carry a mortgage between $300,000 and $400,000.