Home Loan Information

First Time Homebuyers: How Much of a Mortgage Can You Afford?

There are two basic formulas commonly used to determine how much of a mortgage you can reasonably afford. These formulas are called qualifying ratios because they estimate the amount of money you should spend on mortgage payments relative to your income and other expenses.

The following ratios may vary and each application is handled on an individual basis, and so the guidelines are, in fact, just guidelines. There are many affordability programs, both government and conventional, which have lenient requirements for low- and moderate-income families.

As a general rule of thumb, to qualify for conventional loans, housing expenses should not exceed 26% to 28% of your gross monthly income. The ratio for FHA is 29% of gross monthly income. Monthly housing costs include the mortgage principal, interest, taxes and insurance. If your annual income is $38,000, your gross monthly income is $3,000, times 28% = $840. So you would probably qualify for a conventional home loan that requires monthly payments of $840.

Any expenses that extend 11 months or more into the future are called long-term debt, such as a car loan. Total monthly costs, including long-term debt, should exceed 33% to 36% of your gross monthly income for conventional loans. Using the same example, $3,000 x 36% = $1,048. Therefore, your total monthly housing expenses, along with any monthly long-term debt, cannot exceed $1,048. For FHA, the ratio is 41%.

Maximum allowable monthly housing expense 26% - 28% of gross monthly income - Conventional 29% of gross monthly income - FHA

Maximum allowable monthly housing expense and long-term debt 33% - 36% of gross monthly income - Conventional 41% of gross monthly income - FHA

One method of determining just how much to spend for housing is to compare your monthly income with monthly long-term obligations and expenses. Be sure to only include income you can definitely count on.

When budgeting to buy a home, it is important to allow enough money for additional expenses, such as maintenance and insurance costs. If you are purchasing an existing home, gather information on cost averages and maintenance costs from previous owners to help you better prepare for homeownership.

Homeowner's insurance or property insurance is another cost you will have to consider. The lending institution holding the mortgage will require insurance in an amount sufficient to cover the loan. However, to protect the full value of your investment, you might want to consider purchasing insurance that provides the full replacement cost if the home is destroyed. Some insurance only provides a fixed dollar amount that may be insufficient to rebuild a badly damaged house.

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