How to figure out how much you can afford
The Washington Post
WASHINGTON - Perhaps the most anxiety-ridden part of house hunting
is figuring out how much you can afford.
The formula used to be simple. For decades, the thinking was that
your monthly mortgage payment, including taxes and insurance, should
not exceed 28 percent of your gross pay, and that all your loans,
mortgage included, should not exceed 36 percent. Lenders used that
formula to qualify people for loans, and people relied on lenders
to tell them what they could afford.
Today, lenders rarely use this cookie-cutter method. Some focus
more on how much of a person's monthly income goes toward paying
off debt. Some do not use ratios at all. But whatever method lenders
use, borrowers should play it safe and stick to the old formula,
even if it means scaling back expectations, said Christina Diaz-Malone,
director of national initiatives at Freddie Mac.
"You may need to start with a condominium or a cooperative," Diaz-Malone
said. "Look at your purchase as the first investment, and then
Do not assume that because a lender is willing to loan you a certain
amount of money, you should take all of it, Diaz-Malone said.
Instead, assess your financial situation, make a budget and decide
how much you can afford to sink into a mortgage each month.
Start by figuring out how much you now pay for housing. Do you have
to pay the same amount on a home loan? Can you afford to pay more?
If so, how much?
That's where mortgage calculators come in handy, said John Mechem,
a spokesman for the Mortgage Bankers Association.
The most basic of these online tools allow a would-be borrower to
calculate a monthly payment by plugging in the loan amount, the length
of the loan and the interest rate. Current rates can be found on
the Internet, in newspapers, and from lenders or brokers. The tally
will not include payments for homeowner's insurance or taxes held
in an escrow account to be paid later.
There are variations to the basic calculator, many of which can
be found at www.homeloanlearningcenter.com, an educational Web page
recently launched by the mortgage bankers group.
One calculator on the site estimates what size mortgage you can
afford based on your current rent, the expected down payment, and
the anticipated taxes and insurance. Another compares monthly payments
and interest costs, using up to five interest rates simultaneously.
And one compares the payments and interest costs using various loan-term
Similar calculators and basic mortgage information can be found
at Bankrate.com and on the Federal Reserve's Web site, at www.federalreserve.gov/apps/mortcalc.
"Play around with calculators to figure out what sort of mortgage
amount is affordable under your budget," Mechem said. "They're
not going to be accurate down to the individual dollar amount, but
they will give you a good ballpark figure of what a loan would cost
on a monthly basis."
Also factor in whether that monthly payment is going to change over
time, said Frank Quesada, homeownership specialist at the Washington
nonprofit group NeighborWorks America. Adjustable-rate mortgages
start with low rates that can later spike, sometimes doubling a monthly
"Borrowers need to feel comfortable that they can handle an
increase," Quesada said. They should know when their loan adjusts
and what the maximum adjustment is.
The Fed's online "Consumer Handbook on Adjustable-Rate Mortgages" includes
a worksheet to help borrowers determine whether they should get that
type of loan. The Fed advises borrowers to ask themselves: Is my
income enough, or likely to rise enough, to cover higher payments?
Will I be taking on other sizable debts, such as school tuition?
Do I plan to sell before the rate adjusts?
Don't make any decisions before talking to professionals, though.
Shop around for the best rate. Talk to many lenders and mortgage
brokers, "then make sure you're comparing like mortgage products
- a 30-year, fixed-rate loan to a 30-year, fixed-rate loan," Mechem
Sorting through mortgage options can be cumbersome and overwhelming.
If you're not getting the answers you need, keep digging. Consider
seeking advice from a HUD-approved housing counseling group listed
These counseling services are not just for low-income first-time
homebuyers, and they come at little if any cost to the consumer,
who may have to pay the cost of a credit report, said Quesada of