How Much Can You Afford?

The most common question I am asked is "How much can we afford?" This is somewhat of a loaded question as only the borrower can answer it.  However, I can tell you what a bank would qualify you for in terms of a mortgage.

The math is relatively simple.  Banks use two ratios that every borrower should know:  Front & Back ratios.

The front ratio is just the total housing payment divided by the borrowers' gross monthly income.  The total housing payment consists of the principal, interest, taxes, and insurance; also known as PITI.  Simply divide the proposed PITI by your gross monthly income and the resulting percentage ideally would not exceed 28%.  For example, if you make $10,000 per month gross income, typical underwriting benchmarks indicate you should not spend more than $2800 per month on PITI.

The more important ratio is the back ratio.  The back ratio is the PITI plus the borrowers' major monthly debts such as car payments, student loans, and minimum credit card payments.  The back ratios should not exceed 36%.  So if the borrower makes $10,000 per month, they should not spend more than $3600 on the PITI and other major debt.

While having a lower percentage is good, both of these ratios are flexible.  Most banks will allow a back ratio up to 45%.  In some cases, we can even go to a 50% or more back ratio.  

A quick tip is that most borrowers' will qualify for 3 to 5 times their household income depending on debt levels and loan size.  So if a borrower has a household income of $100,000 per year, they should easily be able to qualify to carry a mortgage for $300,000 to about $500,000.

The one thing to keep in mind is that when calculating these ratios, bank underwriters are not taking into account borrowers' lifestyle expenses such as cell phones, cable, clothing, travel, eating out, etc.  As such, just because the bank will qualify you for a certain mortgage amount, it does not mean you can actually afford it.  Setting a detailed budget looking at all of your expenses and sticking to it is always recommended.