Homes come in every size, style and price range. Knowing what you can afford at the beginning of your search saves you time and disappointment later on. The following calculations outline the process financial institutions use to determine what you can afford.
First Affordability Rule
Lenders such as banks and trust companies allow you to spend approximately 32%* of your gross monthly income on housing costs (including property taxes, heating and, if applicable, 50% of condominium fees. The ratio of debt to income is referred to as the Gross Debt Service ratio or GDS.
The following calculation will you how much you can afford monthly for housing.
Your gross monthly income __________________________
Spouse’s gross monthly income ______________________
Other monthly income ______________________________
Total monthly income _______________________________
Monthly income x 32% = GDS ________________________
Second Affordability Rule
The second affordability rule is that your entire monthly debt load shouldn't be more that 40% of your gross monthly income. This includes housing costs and other debts, such as car loans and credit card payments. Lenders add up these debts to determine what percentage they are of your gross household monthly income. This is your Total Debt Service (TDS) ratio.
The following calculation will you what you can afford for housing including your outstanding debts:
A) Monthly Income from your GDS Calculation Above x 40% = TDS____________________
B) Add up your monthly payments for loans, credit cards and other debts__________________
Monthly income left for housing costs (subtract the amount from (A) from the amount in (B).
In addition to GDS and TDS ratios, financial institutions base their lending decision on your credit history, job stability and the amount of your down payment. Interest rates also affect the amount of financing you will be able to obtain.
*Please note that many lenders are prepared to exceed these guidelines.
David earns $40,000 annually and his partner Ruth earns $43,500. They have a car payment of $350 per month and a credit card payment of $150 per month.
How much can they afford monthly for housing?
David’s monthly income $3,333
($40,000 divided by 12)
Ruth’s monthly income $3,625
($43,500 divided by 12)
Total monthly income $6,958
GDS ($6,958 x 32%) $2,226.56
They can afford to spend no more than $2,226.56 on monthly housing costs. How much can they afford with their other monthly payments? Monthly debts Car payment $350
Credit card payment $150
monthly housing cost $2,226.56
TDS ($2,726.56 divided by $6,958) = 39%
Because their total debt including housing costs and all other monthly debts does not exceed 40%, they can afford to purchase a home.