Mortgages: How much can you really afford

Can you afford that home loan?

That's a question mortgage companies are applying with ever greater scrutiny these days, so it pays to know what you can afford before you start hunting for a mortgage.

The mortgage company will want to ensure you can afford to make the monthly home mortgage payments and will generally only lend you the amount they believe you can afford. The lender will closely examine your financial situation to be sure of getting the money back -- with interest.

You may be uncertain about how much you can spend to buy a home. We'll give you a basic rule of thumb, and also discuss how the downpayment works.

Take your gross monthly income and multiply that by 0.28. If you're making $50,000 a year, your maximum monthly mortgage payment is $1,166 a month. There are many online calculators you can use to fine-tune this figure taking into account other debts you might have, but of course the mortgage company makes the ultimate decision about to whom they loan money and under what conditions.

How Much of a Down Payment?
Zero-down loans had been getting more popular as lending institutions got more comfortable with them, but they also helped fuel the recent surge in foreclosures because those people became more unlikely to pay off their mortgages.

So forget about not making a down payment. The lender feels that the more money you put down for the home the more likely you are not to default on the loan because you have equity in the home (quite the concept, that).

It is often recommended that you make a 20% or so down payment if you have it. This is known as 80% loan to value ratio (LTV). If you put down less than this, you'll need to get private mortgage insurance, which protects mortgage companies in the event you default on the loan.

Under federal law the lender must cancel PMI when the LTV ratio reaches 78% or, in other words, when your mortgage is amortized to 78% of the original value of the house. The borrower must be current on all mortgage payments and the lender must tell the borrower at closing when the mortgage will reach that point.

Making the decision on how much to put down depends on many things and there is really no right answer. Some folks feel comfortable with a 100% LTV ratio and other people feel very uncomfortable with an 80% LTV ratio. You may very well want to take advantage of not paying private mortgage insurance by putting down more than 20%. If you do not have the 20%, you may want to increase the number of mortgage payments each year to pay off the mortgage more quickly, or build up sufficient equity to avoid paying private mortgage insurance. Also, you monthly payments will be fewer if you put down more money.