If you're in the market for a house, it's critical to evaluate just how much house you can really afford to buy. For starters, it's a question that mortgage lenders seek to answer before qualifying you for a mortgage. To get an answer, you might apply some formulas lenders use, like the front-end and back-end ratios. The front-end ratio addresses your ability to afford mortgage payments, and the back-end ratio addresses your debt load. Let's look at an example:
Imagine that your gross income is $4,000 per month and you owe $1,000 per month in debt -- perhaps for your car, student loans, and some credit card debt.
Lenders will typically want you to spend no more than 29% or 30% of your income on your mortgage. This is the front-end ratio. In this example, 29% of $4,000 is roughly $1,200, so a lender might assume that you can reasonably pay as much as $1,200 per month in mortgage payments.
Meanwhile, your debt payment-to-income ratio is $1,000 divided by $4,000, or 25%. Lenders will balk if much more than 40% of your income is going toward debt.
Once you know how much you can afford for a down payment and how much you can pay each month, you just need to plug the numbers into a formula. You can do this at our Home Center, where an article on this topic includes a link to a handy worksheet. Also, check out these online calculators that can help you with much of the mathematical gymnastics involved. In addition, drop by our Buying or Selling a Home discussion board to ask questions or just learn from what others are discussing.
Finally, think twice before borrowing as much as you qualify for and getting the most expensive home you can afford. Doing so will leave you with maximum mortgage payments, which can become problematic if your life changes a bit, such as if you become unemployed for a while or switch jobs or face unexpected medical problems. Borrow less than you can afford, and you'll enjoy a margin of safety.
To learn more about ways to save money and spend less, check out our Personal Finance area, which is chock full of guidance on insurance, buying a car or home, paying for college, banking, setting up short-term savings, getting out of debt, lowering your tax bill, and more.