In light of all the silliness that went on in the mortgage market over the last few years, I thought it would be a good idea to write a post that focuses on how big a mortgage people can actually afford. It’s obvious from some of the articles I have highlighted over the past few days that lots of people threw caution to the wind and bought whatever the heck they wanted regardless of the consequences.

To compose this post, I’m using an example that was laid out in the book 10 Steps to Home Ownership (Affiliate Link). It’s an old book but I think her example still applies today. I’m also throwing out adjustable rate mortgages and the like and sticking to a 30-year fixed rate mortgage.

To seriously attempt to figure out how much a person can afford to spend on a mortgage requires several steps.

1. Calculate gross monthly income (GMI). This is pretty straight-forward. You simply add up your monthly income from all sources. In this example, we’ll assume a husband and wife who make \$80,000 per year (\$6,667 per month) combined. We’ll also assume that they both plan to continue working for the forseeable future.

2. Determine what percentage of GMI will go toward the monthly debt service. The author uses three different percentages (25%, 33%, and 36%). Of course, the lower the better so we’ll assume 25% for this example. At a GMI of \$6,667 per month, this couple can afford to spend \$1,667 on debt service, which includes other debt besides a mortgage.

3. Determine the MAXIMUM monthly mortgage payment. Using the same numbers found in Step 2, we’ll assume that the only other monthly debt this couple has is a \$400 car payment. Subtracting that from \$1,667 gives them a maximum monthly mortgage payment of \$1,267. Budgeting software can help with this.

4. Subtract property taxes, homeowner’s insurance, and private mortgage insurance (PMI) from the maximum monthly mortgage payment to determine how much can actually go towards the mortgage. We’ll assume property taxes of \$3,000 per year, homeowner’s insurance of \$1,500 per year, and PMI of \$50 per month for a total of \$425 per month. Subtracting this from the \$1,267 we found in Step 3, gives us a net monthly mortgage payment of \$842.

5. Estimate the size of the mortgage. Using the chart below, estimate how much mortgage you can afford based on the net mortgage payment of \$842 found in Step 4. Assuming an interest rate range of 6% – 7%, and a payment of \$842, this couple can afford a mortgage of somewhere between \$120,000 – \$150,000. A lot depends on the interest rate. The lower the interest rate, the more house you can afford.

IMPORTANT NOTE: It’s important to note that this example did not include a down payment or closing costs. This was a calculation of the mortgage size only. That said, it wouldn’t be difficult to factor in those numbers into the equation. This example also did not factor in the tax deductibility of mortgage interest, which can reduce the monthly cost of the mortgage cost as long as you can itemize your deductions.

The Bottom Line

Lots of people were buying WAY MORE HOUSE than they could afford. They could have used a lesson in reality before they signed their life away.

### 21 responses to How Much Mortgage Can You Realistically Afford?

1. Good analysis. I know someone who’s paying about that for his mortgage. He got into it in the days of sane house prices.

2. It highlights how atypical my own situation is that the graph doesn’t actually go low enough on either axis to include my own situation (pay approx \$500/mo, interest rate

3. r,

Sorry, I went a little lower than what my wife and I are paying per month.

4. Afford? Who gets to decide who can afford what? Percentages are arbitrary BS. The only mortgage anyone can afford is the one equivalent to whatever housing cost won’t put them further into debt or destroy their current savings. If a person is renting, they know what their rent is now, as well as their utility and laundry costs. And they know what they are saving, if anything. When they buy a house, they have to find the funds for closing. Then, in addition to making the house payment, they have to worry about maintenance and utility costs.

5. So how does this compare to figuring a rent payment? Reading this, one would assume a rent limit should be pretty close to the mortgage payment limit. Based on these figures, the mortgage we could afford is quite a bit less than our rent payment. But I thought it was “cheaper” to rent?
And how does a 20% downpayment, eliminating your need for PMI, increase your borrowing power?
Even if you go with the hard and fast rules of 2-3 times annual salary for a mortgage, a lot of people are still overbuying.

6. To say that this formula works is not so much correct. The lenders fallow it, but it should be more flexible.
There are safe ways to get and have much more valuable properties.

7. Problem with this figure is that our couple, even with a combined income that is twice the average household income in my area (a large Southwestern city), can’t even begin to own a house: \$150,000 won’t buy you a place in a scary slum, much less a decent house in a middle-class area within driving distance of work. You can get a faceless cookie-cutter tract house an hour or ninety minutes from your office, jammed elbow-to-elbow with your neighbors, for about \$250,000.

Actually, in the central part of the city, for that amount you can get a cute little 50-year-old shack that needs rewiring and replumbing and a new kitchen and a fence and landscaping (I speak from experience: \$25,000 to \$50,000 of upgrades); the neighborhood itself is kinda OK, but the crime-ridden district on the other side of the nearest main drag brings helicopters chasing creeps every day and the school is not the sort of place a couple who could bring down 80 grand would want to send their kids. Well…neither do the poor folks who have to send their kids there, but they don’t have a choice.

What you’re saying is that a reasonably affluent single person or couple cannot afford to buy a house.

8. Just to be clear, gross income means income before income taxes, right?

9. stacey,

Yes, that’s correct.

10. Yes, a reasonably affluent cannot afford a house in most parts of the country anymore because the standards listed above have been widely ignored for the past 5-10 years. Because there was more liquidity to buy houses, prices went up. It was a self fulfilling prophecy.

If those rules were adhered to, your 250K house in the southwest would cost \$120K simply because there would be no (or too few) buyers at \$250K that could afford it.

It’s the same as the dual income trap that has occurred in this country. Once you had a majority of couples both working, prices rose accordingly for housing etc. and so now we need to work twice as hard (two people vs. one) to buy the same goods.

In short, if you throw extra liquidity in the form of funky mortgage terms at the housing market, prices simply rise to reflect the increase in demand such that the end result is we pay more for the same thing. It’s pure and simple supply and demand economics. A few speculators and lucky homeowners benefit in the short term, but over the long-run honest ‘affluent earners’ get screwed.

The only way for this to ever improve and return to more sane practices is to keep this easy money out of the market and not prop it up with phony government bailout programs. Prices will necessarily adjust, eventually to levels that ‘affluent earners’ can afford.

Owning a home is not a ‘right’ as many politicians lead us to believe in hopes of getting themselves elected.

11. I will never take for granted the fact that I can buy a new construction 4 bedroom 3 bath full brick ranch home (~1950 sq ft) for \$180k here. It has allowed me to buy my first house with a 30 year fixed FHA loan that meets these guidelines and still gets a, “wow” response from visiting friends and family. For those who are stuck on the coasts I strongly recommend looking into moving to mid-size cities in the Midwest or Southeast. Check out Nashville, Indianapolis, Louisville, or a host of others. Cheap housing, low crime, and low unemployment. Just my 2 cents but it sure has worked for me.

12. Indeed you are right and we are considering just that when it comes time to upgrade house with a growing family. We live on the coast and it’s gotten way out of control.

13. Good advice overall. I might add that folks should use many of the freely available mortgage calculators found online, for example, I found some good ones at http://www.azcalc.com.

14. Excellent analysis. The sad thing is, many people are incapable of doing basic math like this to determine where they are financially.

Even sadder is the perpetuated myth that you need a \$300,000 or \$600,000 or higher house to live in. Someone above mentioned that a reasonably affluent person or couple cannot afford to buy a house. True, but only in some parts of the country. If you insist on living in those parts of the country and doing something crazy or exotic with a mortgage just to get into a house, you have other, more pressing character issues.

Someone else mentioned “2-3 times annual salary” as a good “rule” for figuring out how much house to buy. I think that’s crazy. I’m single, make almost six figures, and my house didn’t cost much more than I make in a year. I live in a great neighborhood, low crime, 3 bedrooms, big fenced yard, near great universities, a big city, and excellent nationally ranked hospitals.

People have to adjust their expectations. If they refuse to do that, they have to stop complaining. For example, if you have a 60 mile commute one way every day for work, either find a new job or move. If you can’t (or won’t) do either, you can’t complain…you’ve made your choice.

A family member was complaining to me about the high cost of daycare. I asked why she needed daycare. She said she needed daycare so that she could work. I asked her how much of her salary (her husband works as well) was devoted to paying daycare expenses. It was well over 60% of her annual salary. So she needs daycare so she can work, but she works so she can pay for daycare. This is a woman with a college degree and a job in a big company, and she doesn’t get it. A shame!

15. Thanks for this analysis… it was fun to calculate (although I also did a significant analysis before I bought to make sure I could afford the house.)

Based on the calculation, I am spending about \$60 per month above the range of affordability. It’s not the mortgage payment that’s the killer, it’s the property taxes – nearly \$7K per year.

Of course, this all works out provided I remain debt-free aside from the mortgage. Taking on a car payment would blast me out of the water, so I save money every month toward a new(ish) car, just in case.

16. Hey John,

So do YOU have a college education? Because looking at your “family mother,” it would seem that if she were to quit her job and stay home with the kids, the net family income would decrease (by 40% of her salary, which I’m guessing is not insignificant since she works for a “big company”). You may want her to stay home because it conforms to your “values,” but the math isn’t exactly in your favor.

17. John,

I’m curious to where you found a house for \$100,000 that is in a “I live in a great neighborhood, low crime, 3 bedrooms, big fenced yard, near great universities, a big city, and excellent nationally ranked hospitals.”

I live in one of the better real estate markets for big cities right now and you are looking at at least \$130-150K for all of that (and then you’re talking 30-40 minutes out of the city).

I’m guessing either your opinion of the superlatives you used differ from most or you are just flat out making some of it up (or, most likely, what you consider a “big city” isn’t what most would consider a “big city”).

1. - December 7, 2007

[…] unknown wrote an interesting post today onHere’s a quick excerptAssuming an interest rate range of 6% – 7%, and a payment of \$842, this couple can afford a mortgage of somewhere between \$120000 – \$150000. A lot depends on the interest rate. The lower the interest rate, the more house you can afford. … […]

2. - December 9, 2007

[…] JLP at All Financial Matters explains how to determine how much mortgage you can realistically afford. This is a question I hope to tackle someday, and I’ll be certain to reference the work JLP’s already done. […]

3. - December 10, 2007

[…] All Financial Matters outlines a calculation to determine how much mortgage you can afford. […]

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[…] JLP talked about how much mortgage you can afford. Hint: It’s a lot less than a lot of people have been borrowing in the recent past. […]