“How much mortgage can you really afford?” is closely related to “How much mortgage am I allowed to borrow?”, but the truth is that these are different things.
A lender qualifies you to borrow based upon your income and debt load. In general, you should be allowed to use about 28 percent of your monthly gross (pre-tax) income (MGI) to cover the mortgage’s principal, interest, property taxes and insurance (PITI) (plus any mortgage insurance charged when a downpayment is less than 20 percent and any mandated property fees or assessments (HOA, etc). This is often known as the “housing ratio.”
Your total debt load (including car loans, credit cards, student loans and others) can generally not exceed 43 percent (the qualified mortgage standard) but loans sold to Fannie Mae can “temporarily” have total debt-to-income ratios as high as 50 percent of your MGI.
Aside from what you are allowed to borrow, you need to feel a certain level of comfort about the amount you are borrowing, and how this will impact your life choices.
It’s important to remember that calculations are done based on your pre-tax income; your after-tax income will be much lower, of course. The Census Bureau currently reckons that the median family income in the U.S. is about $66,000; dividing this by 12 months gives you $5,500 per month; 28 percent of this figure is $1,540 which can be used for the home’s PITI payment.
How much mortgage you can borrow is also a function of interest rate; as above, the $1,540 at a recent average rate of 4.11 percent — and assuming reasonable figures for taxes and insurance — will qualify you for a mortgage of about $252,000.
Working with a 50 percent total debt to income (DTI) ratio, this says some $2,750 of your MGI can be used toward all debts; subtracting the $1,540 from it says the maximum total required monthly payments for all other debts is $1,210. Anything above this starts to curtail the amount available in the housing ratio (you will only qualify for a smaller mortgage).
That said, with a $66,000 MGI, you’ll probably fall into the 25% tax bracket (single). Considering any additional state income taxes and “payroll deductions” (FICA, SSI, etc.) a working figure would suggest that about 30% of that $66K is gone — leaving you about $46,200 after taxes and such. This is about $3,850 per month take home.
From that $3,850 take home, and at a full 50 percent DTI, you’ll subtract $2,750 for your mortgage and other debts. This will leave you with $1,100 per month to cover everything else in your life, including food, utility bills, cable, internet, cell phones, car and home maintenance… everything.
Although your personal situation may produce different figures, using this example, and given all the other debt you are carrying, the question is “Can you really afford to live on [the remainder] per month, after the mortgage and debts are all taken into account?”
If the answer is no, and your other debts are intractable (or at least here for the long haul) you probably don’t want to borrow as much mortgage as you possibly can… because you may not be able to “really afford” it on any sort of comfortable or sustainable basis.