The typical rule-of-thumb to answer this question is “one week’s gross income”. But because of the tax advantages of home ownership, its really higher than that. 31% of your annual gross income is a workable rule-of-thumb. So, if you have a household income of $ 100,000, then you can afford up to approximately $ 31,000 per year in monthly payments. Divided by 12 months per year, this is $ 2,583 per month.

The secret though, what the money merchants at the banks and mortgage companies don’t want you to know, is that $ 2,583 per month must cover more than merely the repayment of the loan. This payment must cover

(1) the repayment of the principle amount of the loan,
(2) the interest on the loan,
(3) the real estate (i.e., ad valorem) taxes,
(4) the homeowner’s insurance,
(5) any homeowner’s association fees (if you live in a development with common elements, and
(6) any escrow amounts the lender requires.

So let’s look at this. Assume your real estate taxes are (or would be) $ 250 per month and your homeowner’s insurance is the same. That’s $ 500 per month. Now assume you live in a development with common elements, with a payment of $ 100 per month. Now the total is $ 600 per month. We’ll assume there are no more escrow funds to set aside.

The monthly total is $ 600 per month. You can afford $ 2,583 per month. $ 2,583 less $ 600 is $ 1,983 per month. Assuming a 4.5% mortgage, payable monthly over 30 years, then you can afford to borrow approximately $ 391,000. Remember, this is a fixed-rate mortgage. The interest rate does not vary over the life of the loan.

Another work of caution. Just because you can afford to borrow $ 391,000 does not mean you should borrow $ 391,000. You probably also have some credit card debt, maybe a student loan (or two!) and every month brings emergencies you did not foresee. You also have your retirement goals to fund and maybe college educations to think about. It is, therefore, OK to borrow less than you can afford to pay back.