Maximum Mortgage Calculator
It’s common for home shoppers to ask themselves: “I wonder how much home I can afford?” Most of the time, they are really trying to figure out their maximum affordable mortgage. Fortunately, only a couple of values are needed to calculate the answer:
- The most important factor in deriving the maximum mortgage is the household’s annual income. This value should be the household’s gross pay, meaning income before federal and / or state taxes are removed
- An estimate of the annual property taxes, sometimes referred to as real estate taxes
- While this value is less important, the annual cost of a homeowners insurance policy will increase the accuracy of the mortgage estimate
- One set of calculations, more on this later, depends on the borrower’s other monthly debt payments such as car or student loans, personal loans, and / or association fees
- The last data point needed is the annual interest rate on the loan. This value should not be the annual percentage rate, or APR, since that value accounts for other costs such as loan origination fees
The calculator then provides the user with three sets of values:
- The maximum monthly payment the household can afford, which includes the borrower’s other debt / annual expense obligations
- The maximum mortgage payment the household can afford, which is found by subtracting the other debt obligations of the prospective homeowner from the monthly maximum payment
- Finally, we provide two sets of charts each of which shows the maximum mortgage for loans with terms of 10, 15, 20, 25 and 30 years
Once you’ve had a chance to run through some calculations, we’ll explain how lenders use the information derived from the Rule of 28 and 36.
Lenders and the Rules of 28 and 36
An individual’s credit score is one of the most important factors lenders consider when writing a loan. Credit scores take into consideration factors such as an individual’s payment history, credit history, and the amount of their outstanding credit. Since higher credit scores lower the risk of non-payment, lenders may offer more attractive interest rates to individuals with higher scores. However, these scores don’t tell the lender how much debt the household can reasonably repay. In business terms this would be the household’s debt to income ratio. More commonly, two rules are used when determining how much to lend an applicant.
The Rule of 28 – also known as the front-end ratio
This rule effectively states: All the costs directly attributed to owning a home can be no more than 28% of the household’s monthly gross income.
- Under this rule, the maximum monthly payment is found by multiplying the household’s monthly gross income by 0.28
- The maximum mortgage payment under this rule is found by subtracting the monthly cost of property taxes and homeowners insurance from the maximum monthly payment
The Rule of 36 – also known as the back-end ratio
This rule effectively states: All the costs directly attributed to owning a home plus other monthly debt obligations can be no more than 36% of the household’s monthly gross income.
- Under this rule, the maximum monthly payment is found by multiplying the household’s monthly gross income by 0.36
- The maximum mortgage payment under this rule is found by subtracting the monthly cost of property taxes and homeowners insurance from the maximum monthly payment as well as any other monthly debt obligations
Maximum monthly payments and maximum mortgage payments
Given the way the maximum monthly payment is calculated, the value under the Rule of 36 will always be greater than the Rule of 28. Since the Rule of 36 takes into consideration the other monthly debt obligations of the potential homeowner, the maximum monthly mortgage payment will also be higher for the Rule of 36 if those debt obligations are less than 36% – 28%, or 8%, of the monthly household income.
The objective of these rules is to ensure the borrower has enough income to pay for other expenses besides their debt obligations. Keep in mind these calculations consider before tax income. So, if 40% of your before tax income is lost to federal and / or state income taxes and 36% of that income is used to pay for debt obligations, only 24% is left to pay for essential expenses such as groceries, utilities bills, and commuting costs.
Maximum mortgage values under each rule
The above rules are used when lenders, also known as underwriters, are determining an applicant’s maximum “Conventional” mortgage. There may be ways to borrow more money, but this is at the risk of not being able to make your payback commitments. The term “house rich, cash poor” is sometimes used to describe a situation where so much money is going to pay for a home, there isn’t enough money left for other living expenses. This is a concept everyone should consider very carefully prior to making one of the largest financial decisions of their life.