Here’s How to Know How Expensive a Mortgage You Can Afford

If you are buying a home, you’re most likely getting a mortgage to do it. When you take out a home loan, you are making a commitment to pay it back over multiple decades. That’s a huge financial decision because the money you are devoting to your mortgage payments can’t just be used for anything else.

You don’t want to overextend yourself and take out an unaffordable mortgage. If you do, you could end up not being able to do anything else important with your money, from saving for retirement to going on vacation.

So, how do you know how much you can actually afford? Here are some tips for figuring out if your mortgage is within your price range or if you’re risking financial trouble by borrowing.

Consider your debt-to-income ratio

If you want to know if a mortgage is affordable or not, you need to think about how much it is going to cost relative to what you’re bringing home in income. After all, a $10,000 monthly mortgage may be affordable to some people with high incomes, while even a $1,000 mortgage may be a big reach for others.

You also need to consider your other financial obligations. If you do not have any other monthly payments to credit cards, car loans, or other lenders, you can afford to borrow a lot more for your home. On the other hand, if you already have a lot of debt, then committing to a big housing loan may just make your situation worse.

Your debt-to-income ratio gives you a clearer picture of whether a given loan makes sense or not. Most banks consider two ratios:

• Your front-end ratio, which looks solely at how big of a percentage of your income your mortgage will take up
• Your back-end ratio, which looks at how much of your income your total debt will take up

Banks generally want your front-end ratio to be no more than 28% and your back-end ratio to be no more than 36%. So, if you had a $10,000 monthly income, under these guidelines, you’d keep your housing costs to $2,800 and your total debt repayment costs including your new mortgage to 36% or less of your income.

Some banks do allow you to exceed these ratios, but if you want to make sure your mortgage is affordable, you shouldn’t. In fact, it may be best to be conservative and try to keep your housing costs to no more than 25% of take-home pay.

Don’t forget to consider your other financial goals

Debt-to-income ratio is a good starting point to figure out what you can afford, but there’s more to it than that. You also need to think about what else you want to do with your money.

If you want to retire early or travel the world or quit your job in a few years to stay home with your kids, you may not want to borrow as much as the bank says you can. You may want to devote more of your money to other costs.

The best way to figure out what’s truly affordable is to make a budget taking all of these goals and projections into account — then see how much money is left after you’ve accomplished all you need to cover your home loan costs. By doing this, you can make sure your quest for homeownership doesn’t destroy the other financial plans that are important to you.

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