Determining the Right Mortgage Size

Creative Commons image courtesy flickr user nikcname

You are looking at your dream house, and decide that this is the house for you. But then, you look at the asking price, and your heart skips a beat. You need to get an idea of your budget before you start shopping around, else you risk having unfulfilled dreams.

Now lenders may bring in some lingo into the conversation, but you need not be thrown off guard. With some basic calculations, you can get an idea of the best mortgage size for you, and using that, you can determine your budget. Do visit a lender to get pre-approved, in order to get an early budget. 

  1. Follow the given steps to get an idea of the right mortgage size for you:

    Find your total monthly income (before taxes).

  2. Find out your maximum monthly housing expense by multiplying this by 0.28. 28% is the maximum percentage allowed by lenders. This is known as the front-end ratio.

  3. It is time to calculate your long-term monthly expenses, for which you have to allocate 36% of your gross monthly income (Which is used for debts that cannot be paid off within 10 months.

  4. Factor in other monthly expenses, like alimony, child support, credit card payments and anything else that you pay for on a monthly basis that cannot be paid off fully in 20 months.

  5. Now subtract this total from your long-term expenses quote, and you get your monthly housing expense. This is  also known as the back end ratio / debt to income ratio, and makes sure your housing expenses don't exceed 36% of your main income.

  6. Then, compare the numbers you get from step 2 and step 5, and allocate the smaller number towards PITI (principal, interest, taxes and insurance)

Now you do need to consider the fact that the size of the mortgage you consider also depends on the duration of the mortgage and the interest rates. These factors also determine the total amount you pay. This is why getting a loan pre-approved is the recommended way to go about setting a budget. Having a pre-approved loan gives you an idea of how much money you can afford to spend, making home-buying much more easy!