Question

Chapter 5
Financial Planning Exercise 4
Maximum affordable mortgage payment

Using the maximum ratios for a conventional mortgage, how big a monthly payment could the Ross family afford if their gross (before-tax) monthly income amounted to $5,500?
$  

Would it make any difference if they were already making monthly installment loan payments totaling $850 on two car loans?
Maximum mortgage payment they could make would be $  

Answer 1

Solution

The T Family would like to know how big a monthly mortgage payment they could afford if their pre-tax monthly income was $5,500 (using maximum ratios for a conventional mortgage). To do so, they use the affordability ratio.

The affordability ratio for a conventional mortgage states that monthly mortgage payment should not exceed 25-30% of the borrower’s gross income. Additionally, the borrowers total monthly installment loan payments should not exceed 33-38% of monthly gross income.

To calculate the maximum monthly mortgage payment the T Family could afford, multiply their monthly gross income by the high end of the range, or 30%:

= 5500*0.30 = $1650

The T Family can afford a monthly mortgage payment of $1,650

Suppose the T Family was already making monthly installment payments of $850 on two car loans. This will affect the maximum monthly mortgage payment allowed.

To calculate the new maximum monthly mortgage payment the T Family could afford, first multiply their monthly gross income by the high end of the monthly installment loan range, or 38%. Then, subtract the monthly car loan payments from that amount:

= 5500*0.38 -850 = $1240

The T Family can afford a monthly mortgage payment of $1240 with monthly car loan payments of $850.