Here at ReadyForZero, we want to help you stay out of debt. We also realize many people want to own a home and in many situations having a mortgage is not considered a “bad” debt. But if you get stuck with a monthly mortgage payment that is too high, you risk getting crushed by your home loan and could see your financial picture deteriorate.
That’s why most people ask “How much of a mortgage can I afford?” when they start looking for a home. It’s a wise question, and one that requires a slightly different answer for each person.
The most widely used rule of thumb for figuring out how much mortgage you can afford is the “30% rule” which says that you can afford a mortgage payment that amounts to 30% of your gross income.
However, just going by the 30% rule probably isn’t enough to accurately gauge how much mortgage you can afford – nor will it tell you how the lender likely views you financial situation and ability to pay.
Consider Your Own Financial Situation
As with all things personal finance, it’s best not to rely too heavily on the rules of thumb, and instead consider your own situation carefully. Look at your finances, and figure out how much you are comfortable paying. If 30% of your income feels like it will stretch your budget, don’t get a mortgage that big.
I like to go beyond the mortgage payment when determining how much I’m comfortable paying. Add up how much you will pay in property taxes and home insurance, and estimate utilities for your desired size of house. If you decide to use the 30% rule, base it on your total monthly housing costs, rather than limiting it to your mortgage payment.
Better yet, consider using a different rule. Personally, I prefer to keep my housing expenses to no more than 25% of my net monthly income (currently, my housing expenses are a little less than 20% of my monthly income). That’s what I’m comfortable with. I like to have a little breathing room. If my income is reduced, or if something unexpected comes up, I know that I can still make my mortgage payment.
28/36 Qualifying Ratio
In some cases, the 30% rule doesn’t work in your favor anyway. Some lenders make use of what is known as the 28/36 qualifying ratio. This ratio includes a look at all of your debt payments, as well as the mortgage payment.
Your mortgage payment, using this rule, should be 28% of your month income. Your total debt payments (including the mortgage payment) should be no more than 36% of your monthly income.
Can you still get a mortgage if you don’t fit this profile? Yes, you can. However, if your lender uses this ratio, you might not get the best possible mortgage terms if you don’t meet these requirements.
Even if your lender doesn’t require that you meet the 28/36 qualifying ratio in order to get a good deal on your mortgage, it’s a rule that might serve you better than the 30% rule as you look for a home.
Test Your Mortgage Payment
One of the best ways to make sure that you can afford a mortgage, though, is to test it out. Look at potential mortgage costs (it wouldn’t hurt to include other estimated costs of buying a home). Next, look at how they compare to what you pay right now. If you pay $1,200 a month in rent and utilities, and you estimate that your mortgage plus other costs would come to $1,500 a month, that’s a $300 difference.
Can you afford that extra $300 per month? Try it out. Put that $300 difference into a high yield savings account each month. Can you keep it up for at least six months? If you find yourself struggling, or if you need to dip into your test amount to make things work, you might not be able to afford that mortgage.
You’ll either need to find ways to cut back, earn more money, or settle on a smaller mortgage.
What do you think? Does that answer the question of “how much of a mortgage can I afford?” Or do you have your own metrics for answering this question? Share your thoughts in the comments below!
Image credit: 401(K) 2013