How Much Mortgage Can I Afford to Borrow?

How much of a mortgage can I afford by borrow when buying a home? It's a common question among first-time home buyers, and for good reason. Take out more of a mortgage loan than you can afford to pay, and you could become another foreclosure statistic. And that's bad for all parties involved -- for you, the bank, and even the economy.

So in this article I'd like to talk about the key concepts of mortgage affordability and the process of determining how much you afford to pay.

Lenders Cannot Tell You What You Can Afford

Many home buyers wrongfully assume that a mortgage lender will only approve you for a loan amount that you can afford to pay. But this is not always the case. The lending industry is driven by profits -- they are not in the business of looking out for consumers. You are the only one who can determine the affordability of a certain size mortgage payment.

"But a lender wouldn't let me borrow more than I can afford ... they would lose out too, right?" This is a common argument, but it's also a flawed way of looking at this subject. In this country, there is a secondary mortgage market. I won't go into the financial weeds on this, but it basically gives lenders a way to sell off their mortgage loans soon after they grant them. And to a certain extent, it makes them less concerned about what you can truly afford to borrow (because they can sell of the risk associated with the loan).

We are seeing this happen right now, in staggering numbers all across the United States. Lenders gave people mortgage loans that they could not possibly afford, but they "eased" them into the loan with a low initial interest rate and (often) downplayed the risk of a future rate increase. You know the rest. The mortgages reset to higher interest rates, and millions of Americans found themselves unable to afford their mortgage payments. Then came the foreclosure crisis ... the housing crisis ... and, now, a full-scale economic crisis.

I believe I've made my first point. You are the only person who can determine what kind of mortgage you can afford to borrow and pay back. The only thing a lender can tell you is the amount they'll qualify and approve you for -- not the amount you can realistically afford.

So, How Much of a Mortgage Can You Handle?

Assuming I've convinced you that this is entirely your decision, we can move on to the next logical question. How do you determine how much of a mortgage you can afford to borrow?

The first step is to determine your home buying budget. By this, I mean the amount of money you could afford to put toward a mortgage payment every month, after all of your other monthly expenses have been covered. So start by adding up your monthly expenses -- car payment, credit card payments, food, gas, savings, etc. You can leave your rent off, because that payment will disappear when you buy a house (hooray!).

Next, you can take a hypothetical sale price for a home (or better yet, the actual sale price for a home you're interested in) and put it into a mortgage calculator. You can find these calculators online, and most of them are free to use. These tools will ask you for several pieces of data -- (A) the principal amount you need to borrow, (B) the interest rate, (C) the length or term of the loan, and (D) the property taxes. Some of these items are optional, such as the tax and interest amounts. But you'll get more accurate results by entering as much information as possible.

The more advanced calculators will let you enter your income as well, which is even more useful in determining how much you can afford to borrow. You can find these kinds of tools at Interest.com and a few other places.

When you run the numbers, you'll have a better idea of how much mortgage you can afford to borrow, because you'll have an estimate of your monthly payment based on the principal amount you're going to borrow. Compare that number to the amount of money you can afford to pay each month (after your other expenses), and you'll be honing in on your mortgage affordability level.

Keep in mind that the interest rate the lender gives you will have a lot to do with your monthly mortgage payments. So until you know what kind of rate you qualify for, you'll have to use the default setting for interest rate on the mortgage calculator. If you do have all the pieces of the puzzle (the principal, the property tax amount, the interest rate, etc.), you'll get a fairly accurate idea of what you can expect to pay each month for a certain mortgage amount.

Related blog posts:

• Which mortgage type is right for me?
• How to apply for a home loan
• What is a mortgage amortization schedule?