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 ÷ 12
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
Brokers and financial planners will recommend that you spend anywhere between 25% and 36% of your monthly income on household expenses. We're going to use 36%.
$6,250 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 you 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 x12
Multiply that house payment by 12 months, 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, add 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.
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