Determining How Much You Can Afford
Fewer than 10 percent of homebuyers purchase their homes with cash, so chances are you’re going to need financing. Anyone can get a mortgage loan, but not everyone can get a good mortgage loan. The best way to get a low interest rate (and to avoid a default later!) is to not borrow more than you can afford.
Here’s how to figure out a reasonable amount:
Calculate Your Debt-to-Income Ratio
The general rule of thumb is that your mortgage payment should equal no more than 28 to 33 percent of your gross income. And your total debt (i.e. your anticipated mortgage amount plus your car loan, credit card balances, etc.) should not surpass 36 percent of your gross income.
Determine Your Down Payment
Look at how much cash you have saved up for a down payment. The larger the down payment, the lower your monthly payments can be.
Map Your Budget
Use a budget worksheet similar to the one on the right to determine how much income you can spare each month to put toward a mortgage payment. Simply subtract your expenses from your total income.
Do a "practice run” for two months by saving the difference in your anticipated monthly mortgage payment—don’t forget to add 15% for taxes—and your current rent payment. See if you can maintain the lifestyle that you are accustomed to while not neglecting savings activities such as college funds for the kids or your IRA. If you find yourself falling short you may want to consider a smaller mortgage.