How Much Home
Can You Afford?

Debt-to-Income Ratios
To determine your maximum mortgage amount, lenders use guidelines called debt-to-income ratios -- the percentage of your monthly income before taxes.

Generally, a "front" ratio and a "back" ratio are used. The front ratio is the percentage of your monthly income before taxes that is used to pay for your home (including principal, interest, taxes and insurance, along with other applicable fees). The back ratio is that amount plus your monthly consumer debt (car payments, credit card debt, installment loans, and other similar expenses).

A common debt-to-income ratio guide is 33/38. Housing costs are 33% of a borrower's monthly income, with housing and consumer debt totaling no more than 38%.

Calculating Monthly Income
Calculating your monthly income isn't as easy as looking at your paycheck, unless you are a salaried employee. In that case, if you get paid twice a month, multiply the amount on your payckeck by two. If you get paid every two weeks, multiply the paycheck amount by 26 and divide by 12. There are, of course, exceptions including those who do not work year round.

If you are an hourly employee who works a straight forty hours a week and don't earn overtime income, then it's easy, too. Look at your paycheck, multiply your hourly rate by 40, multiply that total by 52, then divide by twelve.

Lenders don't give you credit for what you are currently making for overtime, bonuses or commissions. They average your income from those sources over the last two years, then add that to your regular salary or hourly monthly income.

As a shortcut, you can add the figures from your last two years W2's, then divide by 24. It generally gets you close enough to have a good idea of what your monthly income will be determined to be.

If you are self-employed, then you need two years of what you claimed as income to the IRS, shown through your tax returns.

There are variations and exceptions, but the above should give you the formula to estimate your monthly income.

Stepping Backwards
Now that you have the amount of your monthly income, multiply it by the back ratio mentioned above. For example, take 38% of your monthly income or multiply it by .38. This will give you the maximum amount you can spend on your housing and monthly consumer debt combined.

To figure your monthly consumer debt, total your bills to determine what you spend monthly on creditor debt, not including auto insurance or utilities. For credit card debt, use the minimum required monthly payment unless it is less than ten dollars. The rest should be what you pay monthly for any loans or other types of consumer debt..

Deduct this from the total the lender wants you to spend on housing costs and consumer debt combined (in our example 38% of your monthly income). Now you know the maximum the lender wants you to spend for housing costs.

Determining Monthly Mortgage
If you have an idea of what purchase price you might qualify for, you can estimate what your annual property taxes and homeowners insurance will cost and calculate the monthly equivalent. Add that to your monthly housing cost total to get a true picture of what your monthly housing cost will be.

If you are buying a condominium or buying a home in an area with HOA fees you will also need to add in homeowners association fees and any other related special fees.