Thinking about buying a house in Salt Lake City? If so, I wouldn’t blame you. After all, with safe cities, a great quality of life, and spectacular landscapes—who wouldn’t want to own a home here?
The problem is, prices have been skyrocketing. In fact, over half of Salt Lake City residents report that they wouldn’t be able to afford their own home at today’s prices. (1) This means that if you’re looking to buy, it’s more important than ever to figure out what you can actually afford.
That’s exactly what I’ll show you today. But first, a quick clarification. There’s a common misconception that you determine how much you can afford based on the total price of a house. This isn’t true.
In reality, it’s based on the monthly mortgage payments you can afford, which—depending on factors like homeowners association fees—does not always correlate with housing prices.
To determine the monthly mortgage payments you can afford, lenders use two numbers, called the front-end ratio and the back-end ratio. The industry standard for front- and back-end ratios is 28% and 36%, respectively, but this can vary widely based on your specific situation and the lender you choose.
But wait—what do these ratios have to do with how much you can afford? Well, that requires a bit of math. So grab yourself a calculator and scratch paper, and let’s dive into the numbers.
Here’s how to determine the type of house you can afford in five steps:
Step 1. Determine Your Monthly Debts
This one’s easy. List out all the monthly payments you make, and add them up.
For this step, you only have to include things that would show up on your credit report, such as car payments, student loans, credit card minimum payments, child support, and other loans. There’s no need to add in more general expenses like cell phone bills, rent, Netflix, etc.
Step 2. Figure Out Your Back-End Ratio Max Payment
Once you have your monthly debt number, you can now calculate your back-end ratio maximum payment. All you have to do is divide your annual income by 12, then multiply by your lender’s back-end ratio, then subtract your monthly debts.
It sounds confusing, but it really isn’t. Here’s an example:
If your annual income is $70,000, your monthly debts are $600, and your lender uses the standard 36% back-end ratio, your calculation would be:
$70,000 divided by 12, multiplied by 0.36, minus $600. That equals $1,500.
Put a circle around $1,500—we’ll come back to it in a second.
Step 3. Figure Out Your Front-End Ratio Max Payment
Your front-end ratio maximum payment is easier to calculate. Just divide your annual pre-tax income by 12, then multiply by your lender’s front-end ratio.
Continuing with the example above, it’d be $70,000 divided by 12, multiplied by 0.28. That equals $1,633. So, our back-end maximum payment is $1,500, and our front-end maximum payment is $1,633.
Step 4. Create Your Budget Using The Lower Max Payment
Lenders always use the lower of these two numbers to determine your maximum monthly payment—so in this case, it’s $1,500.
The next step is figuring out what kind of housing prices would result in a maximum monthly mortgage payment of $1,500. This can get confusing as there are many variables involved, so it’s best to use a mortgage calculator for this step.
As you’re working through your calculations, don’t forget to account for homeowners association fees and private mortgage insurance if applicable.
Step 5. Be Realistic
Now, just because you can get a big juicy loan doesn’t mean you should get a big juicy loan.
These calculations are just rough estimates that help lenders assess how much you’ll be able to repay. There is a lot they don’t account for. Make sure to run the numbers and make sure the monthly payment is actually affordable for you based on your unique circumstances.
Instead of thinking in terms of the maximum price you can afford, perhaps it’s wiser to look at it from a different point of view: How little can you spend and still be happy and comfortable? This goes against society’s “bigger is better” mentality. But in terms of wealth-building, it’s a smart move.
Buying a home is one of the biggest financial decisions you’ll make in life. It’s not something you should take lightly. We at Whittenburg Wealth Partners will not only help guide you through the murky waters of home loans and house hunting, but we also specialize in designing personalized financial plans that will set you up for success with all your wealth-building goals.
Austyn Whittenburg is a wealth planner and partner at Whittenburg Wealth Partners, a family-owned and family-operated financial and wealth management firm located in Salt Lake City, Utah. Austyn has 7 years of experience as a wealth planner and spends his days helping business owners, emerging successful families, and their ensuing generations simplify their financial lives and discover meaningful solutions. Austyn received a Bachelor of Science in Finance from Brigham Young University and holds the Certified Financial Planner™ (CFP®) and Certified Business Exit Consultant (CBEC®) credentials, his FINRA Series 7 and 66 registrations, and his life, health, disability, and annuity insurance licenses. Austyn has received high accolades from his broker-dealer, LPL, for his commitment to always putting his clients’ needs and objectives first. Austyn is active in his community of South Jordan, Utah, where he resides with his wife, Ciera, and two young sons, Grayson and Graham.