Transcript of Video:
Hi. I’m Evan Swanson, mortgage professional and certified financial planner based in Portland, Oregon.
Today I’m going to help answer a question we get frequently, which is how much house or how much mortgage can I afford?
What I’ve done is prepared a hypothetical scenario that we’re going to use to help answer that question. What you can see on the screen here is what we call a Debt-to-Income Calculation for our hypothetical couple; Mary and Joe. The Debt-to-Income Calculation, also referred to as Debt-to-Income Ratio, is a calculation that we make for all loan applications that come through the pre-approval process. What this calculation measures is cash flow on a monthly basis.
In the denominator I’ve listed Mary has a base salary of $5,000 per month gross, or $60,000 per year. Joe as well also has a job that pays him $5,000 a month gross, equaling $60,000 per year. Combined, they make $120,000 per year, which equates to $10,000 per month in qualifying income.
In the numerator, we list their existing obligations. You can see here that Mary has a student loan with monthly payments of $350. Joe has an auto loan with monthly payments of $350. Then there’s some credit card debt here with a small balance and payments of right around $100 per month. In terms of their existing obligations, they pay about $800 per month in existing payments.
In terms of measuring that cash flow, from an approval standpoint most banks are going to allow for 50% of the applicant’s qualifying income, less their existing obligations, to go towards a mortgage payment. So what this calculation does for us over here is calculates that their maximum monthly PITI or mortgage payment would be $4,199.
I think we can all agree here that that level of payment for a couple making $120,000 per year is probably a little bit too expensive. It’s not a prudent decision, it wouldn’t allow them to accomplish other financial goals. In the financial planning community, we typically like to see a couple spending no more than 28% of their gross income on a housing payment. Simple calculation, that works out to be $2,800 per month. In terms of what we call a back end ratio, which takes into account the monthly mortgage payment and their existing obligations, we like to see no more than 36%.
Now in this example, it’s the same number. In other words, 36% of their income less the existing obligations, leaves $2,800 per mortgage payment.
From a financial planning perspective, we would like to see this couple keep their payments at $2,800 or less, the idea being that roughly one third is allocated to housing, a third goes to taxes, and a third can go to savings, consumption, and other needs.
Hopefully that helps you understand your situation. Feel free to email or contact me. Let me be a resource for you. Have a great day.