A mortgage is the single largest loan that you will take in your life. A mortgage extends for a minimum of 15 years and a maximum of 30 years. To take on such a large debt you must be aware of your financial capability and future liabilities.

Why should you want to know your annual earning to afford your house payment?

If you take a mortgage, you need to make monthly repayments for the next 15 or 30 years. In that case, your monthly earning must have provision for the mortgage installment and other monthly expenses. Therefore, you must estimate your annual earning and then take a mortgage that fits within your budget.

How can this information help me in arriving at the amount I can take as mortgage for my home?

Simple economic theory states that your monthly mortgage repayment, including the principal and interest must not exceed 25% of your gross monthly income. Add to this real estate taxes and property insurance that adds another 3 to 6 percent. Besides this, you have your food and other monthly expenses and federal taxes that you pay.

Example

We assume that you will make at least 20% down payment for the mortgage in addition to 2 to 5% as closing costs. Visit any home finance website and they will give you indicative cost per thousand dollars for a 15 year or a 30 year mortgage at varying rates of interest. So, if you finalize a house for $150,000 and make a down payment of $30,000, then at 9% for a 30 year mortgage, the monthly payment using figures from the table provided works out to $8.05 per thousand. This means a monthly installment of $ 966 or $11592 per annum. Since we assume this is 25% of your gross income, you need to earn at least $46,368 per annum to service this mortgage. Similarly, if you feel you can take a bigger house then you can go for a 15-year mortgage with a higher monthly installment. Moreover, the equity on a 15-year mortgage builds up faster so you can go for a refinance or move to a bigger house.

How to calculate your annual income to get an affordable mortgage

You can generally qualify for a mortgage that is twice your annual income. However, lenders assess your net worth, your liabilities, and costs of owning the new house before sanctioning the mortgage.

Let us now consider that your monthly expenses include mortgage payments, property taxes, insurance, and maintenance costs. You may need private mortgage insurance if your down payment is less than 20% of the mortgage amount. This is usually 0.5 to 1% of the mortgage amount and a monthly deduction. This insurance amount may increase marginally over the years. Next, calculate your assets including income, savings, pensions, and equity in real estate. Your liabilities include car loans, monthly expenses, and credit card loans. Your emergency funds should include savings that can provide for six months living without any income. Your net worth is the net of your assets minus liabilities. Subtract emergency funds from net worth to get a sum that is available for losing costs and down payment. Next, get the sum of annual expenses and operating costs, minus them from your income. Then add the cost for rent and insurance to get an amount that you can spend on your house in a year. Therefore, your annual income must be almost double of this amount.

Advantage of using a mortgage calculator

As explained above the calculations are detailed and you must not make any errors. It is therefore better to use affordability calculators available at most financial websites to estimate your annual income.

Disadvantage of not using a mortgage calculator

You will end up buying a bigger house and then take a huge mortgage loan that you cannot afford. You may default on your repayments, severely affecting your credit rating. This will hamper your future chances of credit and affect your credibility among lenders