Buying a home is a big commitment. It's likely to be the biggest single financial commitment that you make in your life. Because it's such a huge purchase, you will likely need to borrow money in order to make it happen. Understanding what you can afford is vital if you want to avoid getting in over your head.
But how do you know how much mortgage you can afford? The answer is different for everyone, but a good place to start is the 28/36 qualifying ratio.
Mortgage Affordability: Rules of Thumb
A common rule of thumb used to sketch out mortgage affordability is the 30 percent rule. With this rule, you make sure that your mortgage payment accounts for no more than 30 percent of your monthly income. While this rule can give you a rough idea of what your mortgage payment should be, the rule of thumb known as the 28/36 qualifying ratio might be a better choice.
The 28/36 qualifying ratio is used by many lenders to determine whether or not you qualify for the lowest mortgage interest rates. Your mortgage payment, using this measure, should amount to no more than 28 percent of your monthly income. Your total debt payments (including your new mortgage payment) should not exceed 36 percent of your monthly income.
When you use the 28/36 qualifying ratio to guide you in deciding how much mortgage you can afford, you are more likely to choose a comfortable-sized mortgage. This ratio prevents you from choosing a mortgage that adds to your monthly obligations in a way that stretches your budget too far.
How Comfortable Are You?
Ultimately, though, such rules are only guides. You need to assess your own financial situation and determine what you are comfortable with. How difficult would it be to pay your mortgage if you had a financial setback? Will you have to give up other activities in order to '"afford'" your mortgage? Consider whether or not your mortgage payment will put pressure on your finances.
Take your mortgage payment for a test drive. Figure out the difference between your current rent payment, and what you would pay with a mortgage, and set that amount aside for six months. So, if your current rent payment is $1,000 a month, and your mortgage would be $1,500 a month, set aside $500 in a high-yield savings account. If you can do that easily for six months, chances are you can afford the mortgage payment. If you find yourself regularly dipping into your savings, or setting aside less, you might not be able to afford that mortgage payment, and it may be time to adjust your expectations.