If you’re a future homebuyer, you might have used one of those “How much mortgage can I afford?” calculators online. These calculators typically gather information like your down payment amount, credit score range, monthly or annual income and debts.
Then, they’ll spit out an estimate of what a bank might lend you mortgage-wise.
These calculators work primarily by figuring out your debt-to-income ratio and then how much you can afford to pay for your monthly mortgage payment. This is similar to how banks decide how much to lend you.
The typical bank limit on monthly mortgage payments is about 28 percent of your gross monthly income. Therefore, the bank thinks you can devote up to 28 percent of your household income to your mortgage payment and expenses (including taxes, insurance and association dues).
So when you put your current income and expenses into a house affordability calculator, it will tell you how much you can afford to pay for your home per month. Then, based on factors such as estimated interest rate, tax payments, insurance payments and available down payment, it’ll tell you how much house, in total, you can afford.
And when you eventually apply for preapproval on a mortgage, a bank will do the same thing. It will tell you, at a maximum, how much it will lend you.
Here’s the issue with this scenario: The bank (and those calculators) aren’t telling you how much house you can comfortably afford. They’re only telling you how much, at a maximum, they’ll actually lend you.
Too often, homebuyers shop for homes at the top of their affordability range, only to find themselves in an untenable financial situation a few years later. A temporary job loss or small hike in homeowners insurance payments can send these homeowners spiraling out of control, financially speaking.
On paper, it might look like you can afford that huge home with the big backyard and the picket fence. But it’s best to find out now – before you buy! – whether you can afford your mortgage payment.
Luckily, finding out if you can truly afford that mortgage is easy. All you need to do is try it on for size.
Here’s how it works:
- First, find out how much the house you want would cost you per month, including insurance and taxes. If you want to be really accurate, add in a few other homeownership-related costs – such as maintenance, lawn care, appliance upkeep, etc. – that you aren’t paying now as a renter.
- Then, subtract the rent you’re already paying from that total monthly cost. Write down the difference.
- Finally, on the same day you pay rent, put the rest of your would-be mortgage payment into your savings account. Try this for six months.
For example: Your goal mortgage payment, plus expenses, is $1,500 per month, and you pay $700 per month in rent. So each month when you pay rent, you’ll also put $800 into your savings account.
At the end of six months, you’ll have a pretty hefty savings account. And you’ll have “tried on” your mortgage payment. If you can comfortably afford the payment for six months, you’ll probably be fine paying that actual mortgage.
But if you had to squeeze your budget too tight to afford the payment – or if a minor emergency required you to take money back out of savings – then you might want to rethink your mortgage goals.