Do Lenders Really Know How Much Home You Can Afford?

“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain” - Mark Twain 

Individuals in the process of buying a home with financing usually get a “maximum loan amount” from the bank. Some assume this is a reasonable estimate for what they can actually afford.  

The maximum loan amount is what the bank feels that you should be able to afford, which can be as high as 31% of your pre-tax income. However, outside of looking at outstanding debt, they really don’t have a feel for what your lifestyle or financial goals are; and that can vary greatly by the individual.  

Take for example the following three families who all live in the same area and purchase 3 different homes with the mortgage equal to 31% of their gross monthly income. We assume each family saves 15% of their income for retirement and pays $500/month in health insurance premiums.  

Family #1 has $4,800/month left over, #2 has $2,900, and #3 has $1,250 after paying taxes, health insurance, and their mortgage. Even though each family is living in a home that the bank believes to be “affordable” for their income level, each has drastically different amounts leftover for essential expenses. Family #1 will likely be fine, #2 may be a little tight, and #3 will be drowning with only $1,250 left for groceries, utilities, transportation, and other costs.  

Before accepting the maximum loan amount, take a moment to think about what you personally can afford and what other expenses you have that the bank might not consider. Things like charitable giving, childcare, and personal care can vary greatly by the family and make a big difference in how much debt you can afford.  

Thank you for reading,

Alex

This blog post is not advice. Please read disclaimers.

1 - Smart Asset Federal Paycheck Calculator. Assumed married couple living in Leesburg, VA with 1 federal, state, and local allowance and 0 dependents. $500/month medical premiums and 15% of gross pay deferred pre-tax in 401(k).