The stock answer given to this question is, if you rent and have cash for a down payment you can purchase a home. But what if you don't rent? Then here's the simplified version of what a mortgage broker would do with you.
Step One: Annual Salary
What is your gross monthly income from all sources? If your annual salary is $75,000, divide this by 12 and you'll see that your monthly income is $6,250.
Step Two: Monthly salary x percent you want to spend.
Broker and financial planners ill recommend that you spend anywhere between 25% and 6% of your monthly income on household expenses. We're going to use 36%. $6,260 x 36= $2,250.
Step Three: Calculate your debt.
Add up your current monthly debt. This Includes things like a car, loan, insurance, school loans, credit cards, and any other personal debt your may have. All of this added together gives you your total debt. Just a guess, but let's say that these add up to $750 a month.
Step Four: Amount you want to spend- Total debt.
Now, take that total debt and subtract it from the amount that you were willing to spend per month to get your maximum monthly payment: $2,250-$750= $1,500.
Step Five: Monthly payment x 12
Multiply that house payment by 12 month, and you have $18,000 to spend each year.
Step Six: Annual payment interest rate.
Divide this annual amount by the current interest rate (I'm using 10%, because it's a nice round number and a good average). So, $18,000- 10 leaves you with $180,000 available for a mortgage.
Step 7: Mortgage + down payment.
Now, take the amount you've calculated that you can afford to pay for a mortgage and the amount of cash you have on hand to make a down payment and you get your purchase price.
So, using the current example: The mortgage was $180,000 plus you have $20,000 on hand for a down payment, then you can afford to purchase a home for $200,000.