Home affordability guidelines before buying a house

“Affordability” is a highly individual concept. When considering buying a home, mortgage lenders put some restrictions on how much you are allowed to leverage your income and assets, which can be helpful, but even these may stretch your financial comfort zone.

Part of a purchase feeling affordable is whether or not it cramps or constricts the kind of life you want or hope to live. Mortgage lenders generally allow you to use 28 percent of your monthly gross (pre-tax) income to cover principal, interest, taxes, insurance and other property-related costs (called the “front end” or “housing” ratio), but you may also be allowed to carry as much as 50 percent of your monthly gross income (called the “back end” or “total debt” ratio) to cover your mortgage and all your other debts combined. Anything above this 50 percent “hard cap” and the amount that your mortgage contributes to the total will begin to be reduced, limiting the amount of mortgage you can borrow.

A pile of long-term debts (student loans, car loans, credit card balances) that press you toward this maximum debt-to-income ratio coupled with an income that is only growing slowly and little savings after purchasing a home, it is a good bet that your purchase won’t feel “affordable,” and perhaps won’t for a good long while. You’ll feel financially pinched and have little flexibility for niceties or essentials like food and clothing.

Consider that you have $5,000 per month in monthly gross income ($60,000 per year gross). You may be allowed to use 28 percent ($1,400) for your PITI and housing costs. On top of this, you are allowed to carry another $1,100 per month in other outstanding debts. This leaves you $2,500 per month… but only on a gross basis; you’ll need to consider the actual net figures.

$60,000 per year will put you in the 25% federal tax bracket ($5,226.25 plus 25% of the excess over $37,950). Based on that calculation, your $60,000 gross would be reduced by $10,738 leaving you with $49,262. Add other mandatory payroll deductions for social security, unemployment, etc. and subtracting a couple of percent for likely state taxes and such and you are likely looking at a total remaining income of perhaps $43,000 as net income (about $3,583 per month).

From this take-home pay, you now lop off $2,500 for your mortgage and other debts. This leaves you with $1,083 per month — about $271 per week to cover every other expense in your life — car insurance and maintenance, cable and cell phone bills, food, maintenance on your home — everything. Even if you are super frugal, you are likely to feel pinched, and having taken on a sizable new debt that squeezes you will most certainly make your home purchase feel “unaffordable.”

In other times, the “back end ratio” was a much more conservative 36 percent, so the amount of new debt you could take on was more limited (meaning smaller mortgage balances and less-costly homes purchased). In the example above, this 36% cap would mean total debts not exceeding $1,800 per month — so in order to borrow the maximum 28 percent of your income for your PITI payment, you would not be able to carry more than $400 per month in debts. This would mean not $1,083 per month to manage everything in your financial life but $1,783 — a huge difference in terms of budgetary breathing room.

For most homebuyers (especially first-time buyers) the first few months and even years of homeownership feel unaffordable, but usually this changes over time as incomes rise (and other debts are retired, hopefully). However, to feel “affordable” from the start, you’ll probably want to start with a more conservative stance in terms of the amount of debt you want to try to carry with your income. Just because it is possible to borrow more doesn’t make it a good idea, and certainly won’t contribute to your home purchase feeling “affordable.”

This post was originally posted on Quora.