As a rule of thumb you can estimate what you can afford by multiplying your annual gross income by 2.5. For example, if your annual household income is $50,000, you might be able to qualify for a $125,000 home. This is a very rough estimate – the actual numbers will vary based on different factors like current interest rates and your debt and credit history. Other factors to keep in mind are your current bills and overall debt, your current lifestyle and future plans. But the most important factor in determining how much you can afford is taking an honest look at what you can spend comfortably for your monthly housing costs.
Mortgage lenders typically use two ratios to more accurately determine how much you can afford to spend on your mortgage.
Housing Expense Ratio
Mortgage lenders recommend that your monthly mortgage payment (principal, interest, taxes and insurance) be less than 28-31% of your monthly gross income. This percentage can change based on the type of mortgage you choose and sometimes the area in which you're looking to buy.
You need to factor your other debts into determining an affordable monthly mortgage payment. Mortgage lenders look at whether your total debt is larger than 30-40% of your monthly gross income. Remember, debt is not just credit cards and student loans. It can also include alimony, child support, car loans, and housing expenses.
Typical Lender Formulas:
28% -- Total monthly payment (PITI) = 28% (or less) of your gross monthly income.
36% -- PITI + all monthly debts = 36% (or less) of gross monthly income.