Determining Affordability

How Do Mortgage Companies Determine What You Can Afford?

Here are two industry-standard formulas* that are widely used and compared to tell homebuyers approximately what they can afford.

*Please be aware that these are considered "industry-standard" formulas and although widely used may not apply for every lending institution. We are providing this information to you to get a better understanding of the lending process. Please check with various lenders and ask how their formulas are derived.

Most lenders say that your monthly mortgage payment (including real estate taxes and mortgage insurance) should not exceed 28% of your gross monthly income. The decision made on this formula may vary from lender to lender. Some lenders may allow ratios higher than 28%. Mathematically speaking, your maximum total monthly mortgage payment can be derived by the following formula:

Max. Total Monthly Mtg Payment <= (less than or equal to) Gross Monthly Income x .28

Another formula widely used in the mortgage industry is your "Debt-to-Income Ratio". This requires that your mortgage payment plus any monthly minimum payments on any outstanding loans or credit cards should not exceed 36% of your gross monthly income. Again, the decision made on this formula may vary from lender to lender. Some lenders may allow ratios higher than 36%. Mathematically speaking, your debt-to-income ratio can be derived by the following formula:

Max. Total Monthly Mtg Payment <= (Gross Monthly Income x .36) - Monthly Debt

In comparing these two ratios a qualified mortgage lender can determine approximately how much house you can afford. Other things are also factored in, such as, the loan's interest rate, the loan's term length, and how much money you have available for a down payment and closing costs. Given all these factors you still might come up short in your quest to buy your dream home. In this case you will need to reevaluate those factors that are holding you back. For example, pay down any outstanding loans or debt or consider buying with a co-borrower to increase gross income.