What is the formula for finding out how much of a house we can afford?
There is no simple answer to this question. Any "formula" is going to fall short of looking at all the details of your budget, your costs, etc to determine what REALLY makes sense for you. Consider two employees of the same company that have the same salary and identical savings, credit card, and car debt . . . but one of those employees has no children, and the other has 2 year old twins. Obviously, though they make the same amount of money on paper, the household budgets of those two potential buyers are going to be substantially different for many years to come. A bank cannot discriminate - but a prudent buyer will have to consider real costs in order to arrive at an "affordable" payment.
Fannie Mae and Freddie Mac indicate, as a GUIDELINE ONLY, that the cost of the house payment itself (that is, mortgage, taxes, insurances, and any home owner's association fee) should be no more than 28% of the gross income (before taxes). FHA (government insured loans) indicates that number should be about 31% or less.
Additionally, when factoring in other debt as well as the mortgage (student loans, credit card payments, car payments, etc.), Fannie Mae recommends no more than 36% of the income for all debt. . . and FHA allows as high as 41% or more.
AND . . . in some cases a lender will allow even more leeway here. Consider these instances:
The property is a multi-unit home where there is rental income, or
There are additional family members contributing to houshold income, or
The income in the borrower's line of work is expected to rise substantially in the near future (such as a doctor completing med school or residency) . . .
A lender may allow for up to 45-50% of the gross income to be used in qualifying, provided the lender is assured that the borrower has substantial savings, good credit, history of handling similar payments such as comparable rent, and stability.
To determine how much you can afford, consider the following:
What are your TRUE household expenses going to be in the new home?
How different is that from your current costs - are you currently saving the difference each month? Would you be able to do so? TRY IT for a few months.
How much do you have in savings - would you have enough in a "rainy day" fund if things were difficult for a few months?
How do you expect your income and expenses to change in the coming years?
What payment "scares" you? What do you think you could handle?
When you have a good idea of what makes sense, talk to a local lender you trust . . . using your numbers and his/hers, you should be able to arrive at a safe figure.