The Math Behind Home Affordability: What You Can Really Afford

"The bank approved me for $500,000, so I can afford a $500,000 house, right?"

Wrong. Banks approve you for the maximum they're willing to lend—not necessarily what you should borrow. Lenders profit from larger loans. They're incentivized to push you to the limit of "affordability" as defined by their risk models, not your financial well-being.

True affordability requires understanding the complete picture: income, debts, lifestyle costs, emergency reserves, and long-term financial goals. Let's break down the math so you can make an informed decision—not just follow the bank's approval letter.

The 28/36 Rule: Traditional Affordability Standards

For decades, lenders have used two key ratios to determine mortgage affordability:

The 28% Rule (Front-End Ratio)

Your housing costs should not exceed 28% of your gross monthly income.

The 36% Rule (Back-End Ratio)

Your total debt payments should not exceed 36% of your gross monthly income.

Why 28/36 Isn't Enough: The Reality Gap

The 28/36 rule was developed when:

• Property taxes were lower
• Healthcare costs were a fraction of today's burden
• Childcare costs were manageable
• Student loan debt was uncommon
• One-income households were the norm

Today's reality demands a more conservative approach. Here's why:

Hidden Costs the 28/36 Rule Ignores:

• Maintenance & Repairs: 1-2% of home value annually ($4,000-$8,000 for a $400,000 home)
• Utilities: $200-$500/month depending on climate and home size
• Furnishings: Larger home = more furniture, window treatments, etc.
• Yard Care: Equipment, landscaping, or service costs
• HOA Special Assessments: One-time charges not in monthly fees
• Rising Property Taxes: Reassessments after purchase can spike costs 20-30%

The Smarter Affordability Formula

A more realistic approach uses the 25/20/10 rule:

• 25% of gross income on housing (not 28%)
• 20% of gross income to savings/investments
• 10% buffer for lifestyle flexibility

This ensures you're not house-poor—spending everything on the property with nothing left for life, emergencies, or wealth building.

That $250/month difference ($3,000 annually) is your emergency fund, vacation budget, retirement contribution buffer—the margin that prevents financial stress.

Calculating Your Maximum Home Price

Once you know your affordable monthly payment, work backward to determine your maximum home price.

Step 1: Determine Your Affordable Monthly Payment

Step 2: Subtract Taxes, Insurance, HOA

These vary by location, but estimate:

• Property taxes: 1-2% of home value annually (divide by 12)
• Insurance: $1,000-$2,000 annually ($83-$167/month)
• HOA fees: Check specific properties

Step 3: Calculate Maximum Loan Amount

Use a mortgage calculator or this approximation:

• At 6% interest, $1,000/month = ~$167,000 loan
• At 7% interest, $1,000/month = ~$150,000 loan
• At 5% interest, $1,000/month = ~$186,000 loan

The Down Payment Decision

How much you put down dramatically affects affordability:

20% Down (Recommended)

Benefits:

• No PMI (Private Mortgage Insurance)
• Lower interest rate
• Immediate equity cushion
• More competitive in multiple-offer situations

Downside:

• Requires substantial savings
• May delay purchase timeline

Less Than 20% Down

Benefits:

• Buy sooner with less saved
• Preserve cash for emergencies or renovations

Downsides:

• PMI adds $50-$200/month (0.5-1% of loan amount annually)
• Higher interest rate
• Negative equity risk if prices decline
• Less competitive offers

The Emergency Fund Rule

Before buying, you must have:

• Minimum: 6 months of expenses in savings AFTER down payment and closing costs
• Ideal: 12 months of expenses for single-income households or self-employed buyers

Why this matters: Home ownership comes with surprise expenses. The first year typically brings $5,000-$10,000 in unexpected costs as you discover what the previous owner deferred.

Your Complete Affordability Checklist

Before committing to a home price, verify:

1. Housing costs ≤ 25% of gross income (not 28%)
2. Total debt payments ≤ 36% of gross income
3. 6-12 months emergency fund remains after purchase
4. Still contributing 15%+ to retirement
5. Budget includes 1-2% annually for maintenance
6. Can handle 20-30% income loss without defaulting

If you can't check all these boxes, you're stretching too thin.

When to Spend Less Than You Can "Afford"

Sometimes the smartest financial move is buying less house:

• Early in career: Income likely to rise, avoid tying up all cash now
• Job uncertainty: Commission-based, contractor, or volatile industry
• Planning for kids: Childcare costs can be $15,000-$30,000/year per child
• High student debt: May want to aggressively pay down before maxing housing costs
• Prefer flexibility: Rather travel, save aggressively, start business, etc.

Conclusion: Afford vs. Approve

The bank will approve you for the maximum they can lend. That's their business model.

Your job is to determine what you can actually afford while maintaining quality of life, building wealth, and protecting against financial shocks.

These aren't the same number. The difference between them is called financial security.