How Much Can you Borrow?

As the name of our website implies (and as the #1 Google ranking confirms), we are THE online source of mortgage calculators. Unfortunately, there isn’t enough space in this post to explore all 22 of our mortgage calculator tools, so I’ll focus on one in particular: Home Affordability Calculator.

The purpose of this calculator is to help you figure out the maximum that you can borrow, under a given set of loan parameters. Many borrowers begin the process by trying to find the home of their dreams, and then worrying about if/how they will afford to repay the mortgage associated with it. A better (or at least more conservative) approach, would be to begin by using the Home Affordability Calculator to determine a reasonable borrowing amount, and then go out and look for a home.

The first input in the calculator is your estimated down-payment. If you already have an idea as to a down-payment (which will come from your savings, and not from the loan), you can key it in here. For those of you just beginning the process, you probably won’t have a strong idea of what kind of down-payment will be expected of you. For a conventional mortgage, 20-25% is the standard, while FHA loans typically require only 3.5-5%.

Next, estimate your interest rate. Again, for those just starting out, this will probably be impossible, especially if you aren’t even aware of prevailing market rates. You can find information on regional interest rate levels from the weekly Freddie Mac Primary Mortgage Market Survey. Given that interest rates fluctuate over time and that you may have to pay a higher rate if your credit isn’t perfect, it’s a good idea to be conservative when estimating your rate, perhaps by adding .5% onto an “average” rate [Note: it is assumed that points, which are used to “buy down” the interest rate will come out of your pocket, and hence are not included in the calculation. The same is true for closing costs. Some loans allow you to finance your points, but that is beyond the scope of this calculator].

Length refers to the duration of your mortgage. 30 years is standard, although 15 years is also an option. Estimated front ratio refers to the percentage of your gross (after-tax) income that your PITI (mortgage principal, interest, taxes, and insurance) will represent. The estimated back ratio refers to the percentage of gross income that all of your debt (mortgage, auto loans, credit cards, etc.) represents. Unless you have reason to believe otherwise, you can assume a 28/36 (front/back) ratio, which means that your PITI cannot exceed 28% of your gross income, and all debt (including PITI) cannot exceed 36% of income.

The next step is to enter all of your gross (after-tax) income into the income fields. You should include the income for all parties who will be listed on the loan documentation. The same goes for the debt fields. [Note that you cannot exclude the debt of one of the parties without also excluding his/her income]. This data will be used in conjunction with the ratios to determine how much you are ultimately eligible to borrow, so it’s important to be accurate and truthful.

Then, enter in estimated property taxes (usually expressed as a percentage), as well as homeowner’s insurance, and private mortgage insurance (PMI) which is paid both upfront and annually by high risk-borrowers (i.e. those whose down-payments are less than 20%) to mitigate against the risk of default. If your projected down-payment exceeds 20%, you can leave this field blank.

Finally, click the calculate button, and you will be provided with the maximum that you will be allowed to borrow under the parameters you entered. You can play around with the loan parameters (i.e. increase the down-payment size, change the loan term) and watch the results change accordingly.

It is important to remember that this represents an estimate only. When it actually comes time to obtain your loan, most of the inputs will probably be different from what you originally assumed, so it’s important to be conservative. Last, this formula is designed to show how much you are eligible (the maximum that the bank will lend you) to borrow, and not necessarily what you can afford to borrow. If the housing bust has taught us anything, it is that the gap between these two figures is often larger than most borrowers initially estimated. Plan accordingly, and be conservative!