Rule Of Thumb: How Much House Can I Afford?

Certified Mortgage Advisor
NMLS 1701021
Published 
November 21, 2019

Rule of thumb: How much house can you afford?

So we're going to be talking about what's comfortable versus what you can afford. So there are going to be two big differences in your comfort level. If I don't erase everything, your comfort level versus what you actually can't afford from a mortgage.

Comfort level vs. what you can afford

So let's go ahead and dive in. First of all, we need to talk about the idea behind comfort level versus what you can afford. Sometimes a lot of people ask me how much can I get approved for. And while it's fun to know, how much a bank is willing to give you. It's not a good question. If you're actually looking at long-term growth for you and your family financially. And the reason why is because you want to make sure that your finances have a budget, that's set up, that's comfortable for you and where you are right now, and where you want to grow.

Lenders will give you a lot more money than you're probably comfortable with. So if you ask for the max, sometimes it can be easy to get a little too friendly with a higher mortgage than you should be taking on in your budget.

So first you need to consult your budget, and figure out what's going to be comfortable for you that aligns with everything in your debt payoff plan and in the goals that you have in investing in the future.

Debt-to-Income

So we need to talk about debt-to-income or DTI. So debt income is one of the main numbers. It's a ratio used by lenders and yourself to figure out how much debt you have compared to how much income you have.

How to get your DTI?

So the way that you figure out your debt-to-income ratio is you take your gross income, and you divide that by your monthly minimum debt payments. So your monthly minimum is that payments would be things like what you pay on your car loan, what you pay on your student loans, and your minimum credit card payments. And if you have a mortgage right now, what your minimum payment is on your mortgage.

So you take all of those together combined with what you estimate your mortgage payment is going to be. And then you're going to take your income and divide it by that number. That's going to give you a ratio.

So for instance, your ratio might be 36%. So that would mean is of your salary or of what you make every single month gross that is before taxes, 36% of that amount you pay in minimum monthly debt payments.

28-36 Rule

One rule that's thrown out on the internet is this 28/36 rule. So this is for a 30-year loan. The 28/36 rule basically says your debt-to-income ratio just for your mortgage payment that you're going to get should be 28% or less. But the 28/36 rule would basically say if you have a, let's say $5,000 per month income. So this is $5,000 per month gross.

If you did that times 28%, your max mortgage payment would be $1,400. And then the 36 of that is how much total debt you have. Then if we use the same scenario, if you made five grand a month, times 36, that brings us up to 1800. All right. So this is basically saying the maximum mortgage payment you should take on is 1400. If your debt is another 400. Giving you 1800. Now I don't think this is a fantastic rule and this is a role that I see a lot on the internet.

The problem with $1,400 a month as a mortgage payment on a $5,000 a month pay is a little tight, right? Because you're not taking home $5,000 a month. You're taking less of that because of taxes may because of retirement accounts and you have other bills to pay, maybe some other debt to pay $1,400 a month, it could be tight.

So that's why I think you're always wanting to default back to what's comfortable for you and what fits in your budget, not just these arbitrary rules that you might find online. But 28/36 is a rule that's out there. It's okay. It might be a good guideline for you.

Dave Ramsey Rule

There's also the Dave Ramsey rule. Dave Ramsey is super conservative. With Dave Ramsey, what he's saying is your mortgage payment. Should only be for 15 years. He doesn't believe in doing a 30-year loan or a 25 or 20, only a 15-year loan. And then your mortgage payment should be 25% or less of your after-tax income.

So in this scenario with the five grand a month, let's say your after-tax income was $3,500 a month. So after taxes, you get paid $3,500 a month. What Dave Ramsey would say is you take 3,500 times 0.25, which gives you 875 a month that you're allowed to spend a max. And this would be on a 15-year loan.

Drastic difference in affordability

You have on one side, Dave Ramsey being super conservative, and then you have other roles like 28/36 that are a lot more lenient because over here you could do a 30-year loan, but with Dave Ramsey, it's only 15 years. So those are two roles that you can keep in mind, depending on the kind of strategy that you want to do.

Conventional at 50%

If you're looking at what you can afford as a max normally conventional loans are going to go max up to just under 50% debt-to-income.

FHA at 57%

FHA will actually go up to 57% of that's income. So you can see lenders will give you actually quite a lot of money relative to the income in debt that you have.

But that doesn't tell the full scope of the picture, just because you can get a certain amount of money. It doesn't mean it's a good decision, just because a lender and an underwriter are going to give it to you. Doesn't mean it's a good decision.

Main rule is comfort

Comfort is the main thing that you should be looking at. And what we mean by comfort is looking at you. Make sure that you're tracking where money is going. How much are you spending on gas? How much did you spend on groceries last month? You should be able to know those numbers or look them up in a software that you have or an Excel spreadsheet. Or even if you write it down on paper, that way you can always forecast what money is going to look like for you in the future.

YNAB

This is what's going to help you not have to live paycheck to paycheck and make sure that you build up some savings and some cushion with your money to be able to do. One tool that I use to figure out what's affordable for me is a tool called You Need a Budget or YNAB, it's a, you need a budget.com and it's basically a software that helps me budget everything and make sure that I'm always prepared for next month's expenses.

What's comfortable to you is what you can afford

So ultimately how much house can you afford? Really? There are a bunch of different roles that you're going to find online. This right here is going to show you the max that a lender is going to give to you. But ultimately it's going to come down to your budget. What's comfortable for you. Is this a payment that you want to makeover a long period of time?

And is it going to get in the way of you living a lifestyle that you want to have? If you want to spend money traveling or spend money on your kids or spend money on a hobby that you enjoy, you can't take a big house payment and do those at the same. All right. So focus on your budget, focus on what's comfortable for you.

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