What size home loan can you afford? Really.

Before you embark on your search for the swankiest home in the neighborhood you should get a sense of what size home loan you can expect to achieve.

The size of your home loan is primarily influenced by your gross monthly income, credit history, and cash you can pull together for a home loan down payment. Home loan lenders use this information to judge your ability to pay them back. After all, that is all they are interested in!

I created the chart below to give you an idea of what size home loan to expect in relation to your annual gross income:

Income to Home Loan Size

Gross income (pretax)

Avg. Home Loan Size

$20,000

80,000

$30,000

$120,000

$40,000

$160,000

$50,000

$200,000

$60,000

$240,000

$80,000

$320,000

$100,000

$400,000

$150,000

$600,000

 

Of course, this chart is for reference purposes only. My assumptions are you have ok credit, take a 30-year home mortgage at a fixed rate of 7.5% and will be paying 20% of the home loan as down payment,

Home Loan Planning: The front-end ratio

Yes, I know you saw “ratio” in the title and your eyes glazed over. Don’t worry, the front-end ratio is just a guideline to help you budget your monthly home loan payments.

The general rule is that your monthly home loan expense (including principal, interest, real estate taxes and home owners insurance) should not exceed 28% of you gross monthly income (pretax). The front-end ratio is illustrated in the simple formula below:

The front-end ratio:
Annual Salary x 0.28 / 12 (months) = Maximum housing expense

So for example, if you make $60,000 the maximum you should consider spending on monthly home loan expenses is $1400:

$60,000 x 0.28 /12 (months) = $1400 per month

I created the chart below to illustrate what your maximum monthly home loan expense should be compared to your gross income.

Front-end Ratios: Income to Monthly Home Loan Expense

Gross income (pretax)

Maximum Monthly Housing Expense

$20,000

$467

$30,000

$700

$40,000

$933

$50,000

$1,167

$60,000

$1,400

$80,000

$1,867

$100,000

$2,333

$150,000

$3,500

The front-end ratio is designed to give you an idea of how much you should spend on your monthly home loan expenses. Your personal spending habits dictate and other debt obligations (car loans, health insurance etc) whether you should spend more or less on you monthly home loan expense.

Exception to the Front-end Ratio

If your loan is secured by the FHA (Federal Housing Association) then you get a little extra wiggle room for your monthly home loan payments. Since the FHA insures the home loan you can put about 30% of your gross monthly income towards a home loan (as opposed to 28% with a conventional loan).

 

Continue: Choosing a home loan