© 2015 Shmoop University, Inc. All rights reserved.
Financial Literacy

Financial Literacy

Home Finance Mortgages What Can I Afford?

What Can I Afford?

Your plans might be to win the lottery and buy that $8.4 million condo with the view of Central Park. Sounds nice, but it ain't gonna happen.

Affordability might be a bit of a mood killer, but it's one of those things that you need to think about when buying a home. Buy too much house at too high a price and you won't be able to enjoy your outdoor spa because you'll be too busy working overtime and weeping into damask pillowcases. Better to buy a cute cottage that lets you sleep at night, dontchathink?

There's a Formula for That

In the 1990s, banks still had a spring in their step when talking about the economy, and they would lend to most homebuyers. Back then, banks would use a formula— 4X AGI (or adjusted gross income)—to figure out how much to lend you. If you could find 20% of the total house price as a down payment, the AGI was calculated by totaling up all the income your household made + any side jobs of investments you had.

The problem? It allowed you to borrow a lot, and it led to a lot of abuse, including boatloads of people who ended up really struggling to pay their mortgage.

These days, it's harder to get a mortgage. Might sound like a bummer, but it means you're less likely to take on so much debt that you risk cardiac infarction every time you open a bill.

When deciding what you can afford, here are few things you'll want to consider:

  • How much of a down payment can you get together by saving, working a little harder, or going through the couch for loose change?
  • How much do you and your wife/husband/dog earn?
  • How much debt do you have in student loans, credit cards, and that tab you're still paying off from that wild Mardi Gras trip?
  • How much do you have in savings, investments, and other assets?
  • What are your monthly living expenses like?
  • How long are you willing to pay a mortgage?

If the thought of going through and using spreadsheets and different color pens is totally your thing, let your inner geek free and figure out how much is left over for you to put into a house. Or, if you want to keep things simple, get a rough estimate of what you can afford by checking out an online mortgage calculator.

Just remember: you don't want to get the biggest mortgage you can—this is one area where bigger is definitely not better. Taking on a smaller mortgage means you can put something into savings or investments and can actually afford that nice armchair and cozy slippers so you can enjoy your new place.

People who Shmooped this also Shmooped...