Buying a home is the largest financial transaction most people make in their lifetime. Getting the affordability calculation wrong — buying more house than you can comfortably afford — can strain your finances for decades. Here is how to calculate what you can realistically afford.
The Lender’s Formula vs The Real Formula
Lenders typically approve mortgages up to the point where your total debt payments (housing plus all other debts) reach 43% of gross income — the debt-to-income (DTI) ratio. Being approved for a $600,000 mortgage does not mean you can comfortably afford it. Lenders optimize for loan repayment, not your overall financial wellbeing.
The 28/36 Rule
A more conservative guideline: keep housing costs (mortgage, taxes, insurance) below 28% of gross monthly income, and total debt payments below 36%. On a $6,000 per month gross income: maximum housing costs of $1,680/month and maximum total debt of $2,160/month.
The True Cost of Homeownership
The mortgage payment is just the beginning. Budget for: property taxes (1–2% of home value annually), homeowner’s insurance (0.5–1%), private mortgage insurance if down payment is under 20% (~0.5–1% annually), HOA fees if applicable, maintenance and repairs (budget 1–2% of home value per year), and utilities typically 30–50% higher than renting.
The Down Payment
20% down eliminates PMI and reduces your monthly payment significantly. With less than 20%, you pay PMI — typically $100–$200 per month on a median home — until your equity reaches 20%. FHA loans allow 3.5% down with lower credit requirements but carry mortgage insurance for the life of the loan.
How Rising Rates Affect Affordability
At 3.5% mortgage rate, a $400,000 loan costs approximately $1,800/month (principal and interest). At 7%, the same loan costs $2,661/month — 48% more. Interest rate changes fundamentally alter what you can afford. Always calculate affordability at current rates, not historically low ones.
Final Thoughts
Buy less house than you are approved for. Lender approval is not financial advice — it is a business transaction. The home that fits your budget comfortably is the home that lets you also fund retirement, maintain an emergency fund, and enjoy your life without constant financial stress.