Purchasing a new home is an exciting time in anyone's life. Still, before you take the leap into homeownership, it is important to have a clear idea of how much you can afford to pay for a home. After all, you don't want to pay so much for a home that you are unable to keep up with the payments. As such, it is essential for you to have a good idea of how much home you can afford before you start looking at available properties. One simple way to make this determination is to have a better understanding of the debt-to-income ratio and how it affects the loan process.

How Your Debt-to-Income Ratio Affects Your Loan

The first step toward determining how much how you can afford is to get a good idea of your debt-to-income ratio, which is the relationship between your debt and the amount of money you earn. This figure, which is expressed as a percentage, is used by lenders to determine how much of a mortgage debt you can handle.

Ideally, mortgage lenders don't want to see a debt-to-income ratio of more than 36 percent. If your debt-to-income ratio is higher than this, providing you with a loan will be considered risky. As a result, the lender may either deny your loan application or may charge a higher interest rate.

Calculating Your Debt-to-Income Ratio

To calculate your debt-to-income ratio, you first need to calculate your fixed monthly debt expenses. If you are married, be sure to include your spouse's debt in these figures as well. Things to include in these calculations include car payments, student loans, child support, minimum credit card payments and any other regular debt payments. Bills such as utility and grocery expenses, however, should not be included.

After determining your total debt, calculate your monthly income before taxes and other expenses are taken out of your check. Then, multiply this figure by .36. This way, you determine the total amount of monthly debt you can afford to pay. For example, if your monthly gross income is $5,000, your total allowable debt will be $1,800 because $5,000 multiplied by .36 equals $1,800.

Hopefully, your total allowable debt is less than your total monthly debt. If not, you should seriously reconsider purchasing a home at this time. If your allowable debt is more than your monthly debt, however, you can use these figures to determine the amount you can afford to pay toward a mortgage each month. If you can afford $1,800 in debt and your total monthly debt comes to $800, for example, you can afford to pay $1,000 toward a mortgage debt each month because $1,800 minus $800 is $1,000.

After determining how much you can afford to pay toward a mortgage each month, it is important to remember that there are a number of costs that are included in the monthly mortgage payment. These include homeowner's insurance, property taxes and private mortgage insurance. Therefore, you should keep these costs in mind when trying to determine how much home you can afford.

At times, there are exceptions made regarding the 36 percent rule. If you live in an area with high home prices or if you are getting your mortgage through programs such as the Veterans Administration or the Federal Housing Authority, for example, lenders might be willing to accept a higher debt-to-income ratio. Even so, you should give some serious consideration to a high ratio in order to determine if you will truly be comfortable with making the payment amount required each month.

Posted by Jolenta Averill on
Email Send a link to post via Email

Thanks for sharing that advice Jolenta. There are a lot of young new home buyers out there. I would like to add: Be sure to look into the future a couple of years as TAXES do go up. I also recommend people escrow their taxes. One last bit of advice: Be sure to have a large enough down payment so you don't have to pay mortgage insurance.

Posted by Colleen Brabender on Tuesday, September 7th, 2010 at 11:54am

Great read. It is so important to learn some of the lessons that can be learned from a recession. A huge part of this recession was due to the housing market and lending when people were getting loans just for having a pulse. Well, not that bad, but it sure does feel like it now. The more educated the buyer the better position they will be in when making maybe the biggest financial decision of their lives. DTI is a great way to find out how much you can really afford, because sometimes a buyer may qualify for more, but they cannot afford it in the end.

Posted by David on Tuesday, September 7th, 2010 at 5:05pm


I love your writing style and passion for educating home buyers in the Madison area. You are so right about making sure that you need to make sure you comfortable with what you can afford and understanding how that is determined. Keep up the great educating!

Posted by Green Bay Homes for Sale on Wednesday, September 8th, 2010 at 1:55pm

This is great advice. It certainly is important to calculate the debt to income ratio before considering what price range you are looking for in homes. Great explanation!

Posted by Mesa Real Estate on Monday, September 13th, 2010 at 11:20am

When talking with people about how much they can afford, I like to ask them how much they want to pay. People maxing their purchase can be OK if they are pretty certain about future employment and increasing income. But for others, I often mention caution.

Posted by Dripping Springs Homes on Wednesday, September 22nd, 2010 at 11:38am

Good points for buyers, John. Too many buyers purchase properties based on what they THINK they'll be able to afford in the future, even if it's considerably outside of their means (and obviously banks continue to approve loans in the riskier debt-to-income end of the spectrum).

Posted by Alex Cortez on Friday, October 8th, 2010 at 9:03pm

What an awesome break down, I am terrible with numbers and have always been one to automatically refer lending questions to a specialist, this is hands-down the simplest and easiest to understand break down of the debt to income ratio rule of thumb. You are great with your words!

Posted by miss feliss on Tuesday, April 19th, 2011 at 6:22pm

This is very good advice. At the same time I thin sometimes people get too into what the bank will loan them know they have expenses that are not calculated into the mortgage company's debt to income ratio. Just because the bank says you qualify for a $200,000 home doesn't mean you should borrow that much.

Posted by Divorce Lawyer on Sunday, October 16th, 2011 at 11:55pm

Leave A Comment

e.g. yourwebsitename.com
Please note that your email address is kept private upon posting.