Your family has outgrown their current home and it is time to explore the real estate market.  To make an educated decision regarding how much you can spend on a home, two ratios are key, the “Basic Housing Ratio” and the “Broad Housing Ratio”.

Basic Housing Ratio

The Basic Housing Ratio determines the amount of monthly housing costs (mortgage, interest, homeowners insurance, and property taxes) that a family can afford given their monthly gross pay. This ratio, used by companies to qualify first time home buyers for conforming rate mortgages, works well for consumers with minimal reoccurring debt payments (auto loans, student loans, bank loans, credit card payments, etc.) 

Assume a family with an AGI of $100,000 looks to purchase a home. With a gross monthly income of $8,333, the family would be able to afford monthly housing costs of $2,333. Monthly housing costs of $2,333 translates into roughly a $266,000, 15-year fixed mortgage after accounting for interest, homeowners insurance, and property taxes.

Step 1:                  Basic Housing Ratio =  (Housing Costs)/(Gross Pay)  ≤ 28%

Step 2:                  Basic Housing Ratio =  $2,333/$8,333  ≤ 28%

Broad Housing Ratio

If you are a family that carries a substantial amount of reoccurring monthly debt, the Broad Housing Ratio may be more appropriate.  This ratio combines basic housing costs with all other debt payments (auto loans, student loans, bank loans, credit card payments, etc.) made on a reoccurring basis.

Assume the family example used above now has $800 of monthly fixed debt from auto loans, student loans, and credit card payments. Using the Broad Housing Ratio, the family would be able to afford monthly housing costs of $2,200.  This translates into roughly a $250,000, 15-year fixed rate mortgage after accounting for interest, homeowners insurance, and property taxes.

Step 1:         Broad Housing Ratio =  (Housing Costs+Other Debt Payments)/(Gross Pay)  ≤ 36%       

Step 2:         Broad Housing Ratio =  ($2,200+$800)/$8,333  ≤ 36%

Sources

"Mortgage Affordability Calculator." Chase. JP Morgan, 22 Mar. 2016. Web. 22 Mar. 2016.

Dalton, Michael A. "Financial Planning Approaches: Analysis & Recommendations." Fundamentals of Financial Planning. Vol. 3. St Rose: Money Education, 2015. 85-86. Print.

Provided by Storey & Associates, a Registered Investment Advisor located at 1360 South Main Street, North Canton, Ohio offering Financial Planning and Investment Management Services. Content written by Ryan Bayonnet. For more information, please contact us at (330) 526-8944 or info@storeyassociates.com.