How to Figure Out How Much You Can Afford

By Dina ElBoghdady
Washington Post Staff Writer
Sunday, September 30, 2007

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 move up."

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 http://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 lengths.

Similar calculators and basic mortgage information can be found at http://Bankrate.com and on the Federal Reserve's Web site, at http://www.federalreserve.gov/apps/mortcalc.

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