How Much of a Home Loan Can I Afford?

How much of a home mortgage loan can you afford to borrow? Here’s a hint. A mortgage lender cannot answer this question. You must answer it for yourself, before you even apply for a home loan.

In today’s lesson, I’m going to explain one of the most important concepts a home buyer should understand. Failing to understand this concept can lead to financial problems down the road, including home foreclosure. Are you ready for it? Okay, here it is:

A mortgage lender cannot tell you how much home loan you can afford to take on. They can only tell you how much they’re willing to loan you.

Why do I stress the importance of this idea? Because a lot of first-time buyers take on home loans that are too large for them, simply because the mortgage lender approved them for it. “We figured we could afford the payments since the lender approved us for that amount. Turns out we were wrong.” I can’t tell you how common this statement is. It happens all the time, and it’s one of the most common scenarios that lead to home foreclosure.

Determining How Much Can You Afford

Mortgage affordability is a serious subject. It’s possible to get qualified for a home loan that you really can’t afford, though most people don’t realize it. Mortgage lenders are in the business of making money. They do this by charging interest and fees for the money the lend. They are not, however, in the business of protecting your financial future. So they are in no position to tell you how much of a home loan you can afford to borrow. They can approve or reject your for a loan, and they can assign an interest rate on that loan. But that’s it.

You might ask the question many first-time buyers ask: “Why would a mortgage lender approve me for a loan that I possibly could not afford? Don’t they lose money if I get in over my head?” It’s a logical question. But here’s how lenders avoid risk. Many of them sell the loans they make into the secondary mortgage market (which is fueled primarily by Freddie Mac, a name you’ve heard in the news a lot lately). In a certain sense, this relieves the lenders of the “burden” of making responsible loans.

Here’s the bottom line. Don’t trust a mortgage company to tell you how much of a mortgage payment you can afford each month. It’s contrary to what they do. They sell loans and make money — that’s it. So you’ll have to determine your level of affordability. Here’s how to do it.

Create a Buying Budget

How much home can you afford to buy, without sacrificing things that are important to you? That’s the real question that lies at the heart of this issue. After all, what point is having a nice house if you can’t afford to furnish it, or to entertain, or to do any of the things you used to enjoy? You don’t want to be “house poor.” That’s where your home buying budget comes into the picture.

Start by adding up all of your monthly expenses. This will include groceries, credit card payments, car payment, health insurance, savings, entertainment items, etc. You can leave your rent out of this equation, because you won’t be paying rent after you buy a home … yay! Add in utilities, as well. You won’t know exactly what this comes to, since you don’t actually own a house yet, but a good estimate will suffice.

Now take the monthly expense amount you came to above, and subtract it from your gross (after taxes) monthly income. This is the amount of money you’ll have to put toward a mortgage payment. This amount will give you a general idea of how much home loan you can afford to borrow. It doesn’t mean you’ll get qualified for that amount — that’s up to the mortgage lender. But at least you’ll know where your affordability level lies, and that’s the whole point of this article. You should find out how much you can afford before you even begin talking to a lender.

Using Home Loan Calculators

In the previous exercise, you determined how much of a monthly payment you could handle. So how do you translate that into actual houses and asking prices? You do this by using a home loan calculator. Also referred to as a mortgage calculator, these handy tools will reduce the sale price of a home into monthly payments. They also factor in the interest rate and the term (length) of the loan. You can find dozens of them online by doing a Google search, and they’re almost always free to use.

Just keep in mind that you won’t know what interest rate you qualify for until you get a mortgage quote from a lender. The interest rate is part of the quote. So when you use a mortgage calculator, just use the average rate currently being offered (the calculator will probably have this filled in already).

Conclusion and Going Forward

We have covered a lot of information in this lesson. So let’s summarize the key points. A lender cannot tell you how much of a home mortgage loan you can afford to take on. You must determine that for yourself, before applying for a loan. Here’s how to do it:

• Start by adding up your monthly expenses (minus rent).
• Subtract these expenses from your gross monthly income.
• The amount you have left after this subtraction could be put toward a mortgage payment.
• Use a home loan calculator to break the asking price of a house into monthly payments.
• Limit your house hunting process to properties within your budget level.
• Do not take on more of a home loan than you can afford — it’s a recipe for foreclosure!

If you already have an idea of what you can pay each month, and you’re ready to get some quotes from lenders, visit the mortgage quotes page of this website.