Years ago, the general rule of thumb was that you could afford a house that cost two and a half times your annual salary. Today, most people finance their home purchases. As a result, determining how much house you can afford generally equates to how large a mortgage you qualify for and how much of a down payment you will make.
To determine how large a mortgage you qualify for, lenders use formulas known as qualifying ratios. Generally, these qualifying ratios are based on your gross monthly income, your housing expenses, and your long-term debt. To qualify for a conventional mortgage, your housing expenses should generally not exceed 28 percent of your gross monthly income. Your monthly housing expenses include mortgage principal, interest, taxes, and insurance (often referred to as PITI). In addition, the Consumer Financial Protection Bureau’s mortgage rules suggest that borrowers have a debt-to-income ratio that is less than or equal to 43 percent. That means that you should be spending no more than 43 percent of your gross monthly income on longer-term debt payments.
When shopping around for a mortgage, compare the mortgage rates and terms that various lenders offer, and then get preapproved or prequalified with the lender of your choice. That way, you’ll know exactly how much you can afford before you begin searching for a house.