A mortgage payment can take a major bite out of your paycheck. To decide how much mortgage you can afford, you must look beyond the total income you and your partner earn each month. Most mortgage lenders will decide how much mortgage you can afford based on a percentage of your income, so you should start there as well.
The 28 Percent Rule
In general, lenders follow the "28 percent rule" — meaning no more than 28 percent of your gross income should go to your mortgage. To calculate how much you can afford to spend on housing, start with your total monthly income before taxes. Multiply that by 0.28 to get the maximum amount you should spend on a monthly mortgage payment.
One way to figure out how much mortgage you can afford is to calculate a front-end ratio. This ratio considers the expenses you will have to pay when you have a mortgage, including the mortgage payment and all those things it's easy to forget about when you've found your dream home: homeowner's insurance, property taxes and possibly private mortgage insurance, known as PMI. Once you've calculated the monthly total for these expenses, compare the total to your monthly income multiplied by 0.28. If these expenses exceed that number, you probably need a lower mortgage amount.
You can also use a back-end ratio to help you determine how much mortgage you can afford. For this calculation, you'll consider your debt-to-income numbers. To do this, add up all of your debt obligations for an average month, including mortgage payments and related expenses, car loan payments, credit card bills, student loans and other recurring debt payments. Then compare this to 28 percent of your income. If your total monthly debt obligation with a particular mortgage amount will be more than 28 percent of your income, you need a lower mortgage payment.
While you may be able to afford a mortgage with payments that are 28 percent of your income, this doesn't mean you should take out one that large. Instead, try to get your dream home at a low interest rate and put down as much deposit as you possibly can. This way, you may get away with spending less on a mortgage and having more money to invest or sock away for a rainy day.
Loss of Income
No one likes to think about the loss of a job or business income, but it's always a possibility. To ensure that you won't lose your home if you or your spouse loses an income source, obtain a mortgage that one of you could afford for at least a year on one income. Doing so may help you rest easier.
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