How Much Can You Afford Without Overextending Yourself?

Since buying a new home is probably the largest purchase you will ever make, one of the first steps you need to take is to analyze your finances. And because your mortgage will be a debt you’ll have for many years to come, you really need to look as far into the future as you can. One of the first questions you should ask yourself is: how much can I afford without overextending myself? By planning for the future and analyzing your debt-to-income ratio, you can get a fairly realistic idea of how much you can afford.

In general, you should look at three areas when you’re considering how much you can afford: job status, future debt, and how much is really required to buy a house. When you think about your job status ask yourself where you are, where you’re going, and where you’ll be. Is the job steady? Do you plan on leaving your current company? How sure are you of future promotions? If possible, look five to ten years down the road. Future debt will also factor into housing affordability. Are you planning on having kids (or more kids)? Is your vehicle on its last legs? Try to consider any large purchases you may be planning on making. Finally, make sure you understand that affording a house doesn’t mean just affording a mortgage. Total housing costs will include agent commissions, lender fees, escrow, title, and closing costs. All of these up-front costs could run as high as five or six percent of your total loan. Plus, leave room in your budget for maintenance, upkeep, and upgrades on your new house.

When you sit down to do your budget, you need to make two different specific calculations. The first calculation is called a front-end ratio or monthly housing expense. For this, you need to figure out how much of your gross monthly income can go towards your mortgage. Generally, your mortgage should not exceed 28 percent of your gross monthly income. If the percentage is any higher than that, you may be getting in over your head. Secondly, figure out your back-end ratio, which is also referred to as total housing expense. Here, figure out how much total debt you have and what percentage of your gross monthly income is eaten up by that debt. As a rule, your total debt should be at or below 36 percent of your income. Remember, however, that these numbers are ballpark figures; the 28/36 rule is a good guide, but it’s just that—a guide. Although the internet is filled with sites that can calculate these ratios for you, how much you can afford will also depend on what type of loan you can get, the interest rate, your credit history, and other factors. You should always consult your mortgage banker for specifics.

The key to affordability is to not overdo it. Put plenty of cushion into your budget and ask your lender for a pre-qualification (a quick analysis of your income, assets, and debt). Although most lenders are flexible in terms of working with your financial situation, you can get the best deal if you’re honest with yourself about your current and future finances and your debt-to-income ratios are in line.