How much home can I afford on my salary?

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Buying a house is arguably the most important purchase of a lifetime. There are many benefits to home ownership, including tax write-offs and the freedom to do as you choose (with some exceptions) without having a landlord knock on your door. Yes, a place to call your own comes with rewards, but there are also responsibilities. The landlord, who isn't lording over you anymore, also isn't writing a check to the plumber and the lawn guy. And most importantly, home ownership is a big financial commitment. Here are some tips for figuring out how much home you can afford on your salary.

Your Financial Picture

Your debt-to-income ratio will determine the amount of money a bank will lend you.
Your debt-to-income ratio will determine the amount of money a bank will lend you.
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A small but growing number of financial experts are recommending that you save your money and pay for your home in-full. For many, that seems unrealistic. The vast majority of homeowners borrow at least a portion of the funds necessary to make their purchase.

Banks will want to take a look at your overall financial picture before deciding how much they're willing to lend you. Your income factors heavily in their decision, but so does the amount of debt you have. And it's not just credit cards -- school loans, car loans and any other money you've borrowed counts toward your total debt. Most mortgage lenders want to see your debt-to-income ratio below 36 percent, which means your debt doesn't exceed 36 percent of your yearly income. Some mortgage lenders may make an exception, but that exception will cost you in terms of a higher interest rate. And such exceptions are increasingly rare.

General Formulas

A mortgage calculator will give you a general idea of what your monthly payment will be.
A mortgage calculator will give you a general idea of what your monthly payment will be.
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There are a couple of general formulas for figuring out what you can afford. Lenders and other financial experts used to suggest that buyers spend no more than three-and-a-half times their annual salary on the price of a house, resulting in monthly payments between 28 and 33 percent of gross monthly income (before taxes).

As a result of the housing and job crisis, experts are becoming more conservative with their recommendations. If you can't pay for your home in-full, conservative financial experts recommend a 15-year mortgage with a resulting monthly payment no larger than 25 percent of your take-home pay. The broader consensus is that you should be able to make a 20 percent down payment on your home, and plan to spend 28 percent or less of your gross income on your monthly payment, including taxes and interest.

What are you comfortable with?

A mortgage calculator is a useful tool, but it doesn't take your personal goals into account. Are you planning to start a family? Do you have children who will soon be going to college? What's affordable now may constitute a financial burden later.

Also keep in mind that "can" and "should" are two completely different words. Just because you can get a large loan doesn't mean you should. That's one of the big lessons from the recent financial crisis. And finally, you have to determine what gives you peace of mind. The amount of risk you're willing to accept is a very personal matter.

Related Articles

Sources:

  • Burnette, Jack. "How Mortgage Calculators Work." Ezinearticles.com, 2010.http://ezinearticles.com/?How-Mortgage-Calculators-Work&id=971288
  • "Calculating your debt-to-income ratio." Lendingtree.com, 2010.http://www.lendingtree.com/mortgage-loans/advice/qualifying-for-a-loan/calculating-debt-to-income/
  • Morgan, Sarah. "How Much House Can You Afford Now?" Smartmoney.com, July 21, 2009.http://www.smartmoney.com/personal-finance/real-estate/how-much-house-can-you-afford-now/
  • Ramsey, Dave. "How Much House Can You Afford?" daveramsey.com, August 3, 2009.http://www.daveramsey.com/article/how-much-house-can-you-afford/100362/
  • Weston, Liz Pulliam. "Don't Bite Off Too Much House." MSN Money, 2010.http://articles.moneycentral.msn.com/Banking/HomebuyingGuide/Don'tBiteOffTooMuchHouse.aspx