When you're buying a home or refinancing a mortgage—as record number of us are doing these days—one of your most important considerations is what size mortgage you can realistically afford. To figure out that number, just follow the steps below.
1. Calculate your net monthly income. That's your income after taxes, Social Security contributions, retirement contributions, etc.
Example Figure A
Let's say your current net monthly income is:

$4,500.00		 Your Figure A
Enter your current net monthly income (without commas):

$ .00

2. Next, total up monthly payments on your debt—all your debt: car loans, credit card balances and/or student loans. (Exclude your rent or mortgage payment.)
Example Figure B
Let's say your monthly debt payments are:

$1,000.00		 Your Figure B
Enter your total monthly payments (without commas):

$ .00
Your Figure B is % of Your Figure A.

If Figure B is more than 25 percent of Figure A, you must reduce your debt before you can afford to pay a mortgage.

3.
Add up all your monthly living expenses. Go back over a year's worth of expenses and tally every check and card charge purchase, including those for your monthly transportation costs, drying cleaning, food and entertainment, vacations, birthday gifts, holiday expenses and other miscellaneous costs (excluding mortgage payments). Next, total all these expenses and divide by 12.
Example Figure C
Let's say that your current monthly expenses on average come to:

$1,500.00		 Your Figure C
Enter your current monthly expenses (without commas):

$ .00

4. Add Figures B and C together to get Figure D.
Example Figure D
In this example, that would be $1,000 + $1,500 =

$2,500.00		 Your Figure D
Your Figure B + Your Figure C =

$ .00

5. Now, subtract Figure D from Figure A.
Example Figure E
In our example, this would be $4,500 - $2,500 =

$2,000.00		 Your Figure E
Your Figure A - Your Figure D =

$ .00
Figure E is the maximum monthly amount you can afford to spend on all home ownership costs.

6. Reduce Figure E by 30 percent to get Figure F.
Example Figure F
In our example, this is $2,000 - ($2,000 * .3) =

$1,400.00		 Your Figure F
Your Figure E - (Your Figure E * .3) =

$ .00
Figure F is the highest monthly payment you can afford to make for a mortgage alone. Remember, you will still need that 30 percent (and sometimes even 40 percent) to pay for property taxes, home insurance, etc.

What size mortgage you can afford will also depend on available interest rates, the length of the mortgage and whether you get a variable- or fixed-rate mortgage. A difference in interest rates of even half a percentage point can mean a lot. The monthly payment for a 30-year fixed mortgage of $300,000 at 6 percent is $1,799. But at 6.5 percent, the monthly payment on the same mortgage is $1,896—a difference of almost $100.


This formula does not account for the tax savings conferred by home ownership. You will want to figure that savings into your calculations before you shop for a home. A tax advisor can help.
Published 08/14/2008

NEXT STORY

Next Story