If you’re considering getting a new mortgage and wondering just how large you should go. This post is for you. It’s kind of a catch 22 right? We want big, but the smaller we go the more financial security it gives us. Or does it?

Look, it has been ingrained in my mind for years that you shouldn’t take out a mortgage that’s going to make you “house broke”. I mean after all that extra money is money you can spend elsewhere, or save! Right? Well, the truth is it isn’t that black and white and there is also this gray area that you need to consider.

What am I talking about? 1 word-equity.

Before we talk about equity, I want to give you a quick disclaimer. I’m not a financial advisor and this isn’t financial advice. Just simply me writing down my opinion, that could maybe strike a chord in some way with you. However, it’s up to you decide your own financial decisions and this isn’t meant to make those decisions for you.

On that note: equity. Let’s talk.

As you make mortgage payments each month you’re going to pay the balance down on your home, thus building equity in your home. Kind of obvious right?

But why on earth would this matter? You could simply take out a smaller mortgage and make larger payments right? This would build just as much if not more equity right? More would go to principle!!

It seems this is the logical answer on the surface. And to be honest, a lot of times it is. But let me give you a quick example of how purchasing towards the highest end of your budget could pay off immensely down the line.

Market Increases Can Give Equity Gains

Let’s give a specific example here. Colorado has had some insane housing increases over the last decade. If you were one of the lucky souls that purchased a home there (in the right area) shortly after the 2008 housing bubble, then there is a good chance that you doubled your home value since then.

Do you see where I’m going with this? The larger home value you have to begin with, the bigger your equity gains will likely be, without doing anything besides keeping up with your house which you’ll have to do anyway.

A 150k house could be worth 300k over that time period whereas a 300k house could be worth 600k. So take a step back, and think about had you timed the market right where you could be at today.

But buyer beware, this could work the exact opposite way as well. Buy your home right before the housing market bubble bursts again and you could see losses instead of gains.

So, what that means is high-risk/high-reward if you’re maxing out what you can afford on a mortgage for equity gains. The good thing is that the housing market has gone up the last 50 years and will likely trend up with inflation over time.

Does this mean go big or go home? We’ll get into that in a bit because there is more to consider. First off, let’s just answer the question you’re here for.

How Large of a Mortgage Can You Get Approved For?

First off, just let the cat out of the bag, the answer is: probably a lot more than you should.

Literally, banks will throw large loans at you that you have no business whatsoever getting. So if you’re wondering if you’ll be able to go a bit larger, the answer is. Absolutely. Should you? Well hold up we haven’t gotten there yet.

But here’s what they’ll hand out to you.

The general rule falls somewhere around this: the max most lenders will give out is 28% of your pre-tax income and 36% of your total debt payment. However, this is a general rule and some lenders may even lend out as high as 40-45% of your pre-tax income. Lenders are encouraged to stay under 43% of your total debt to income ratio, but that doesn’t mean some lenders won’t approve you for an even higher number than that.

What I’m talking about for approval on “pre-tax income” is referring to the total monthly mortgage payment which consists of principal, interest, insurance, and taxes compared to your monthly gross pay. In other words, if you make 80k a year then based on this number you would be able to get a mortgage payment from most lenders that is $1,866 (28%) per month. This of course is 80k/12 x .28. And if lenders go as high as 45% then that means they would approve you for a $3,000 mortgage per month if you make 80k per year if we’re just looking at your income.

The other part I mentioned considers your debt to income ratio. So long story short, they are going to look at your other debt and combine it with the monthly mortgage payment you’re about to take out. That’s where that 36% comes from (which would be, of course, could be even higher).

Anyways, let’s just assume a lender will max you out at 28% of your gross income and 36% of total debt. That means that if you have too much debt they won’t approve you for 28% of your gross income. It would be the estimated mortgage plus other debt totaling 36% as the max.

So you may be thinking, who are these lenders that approve more? It doesn’t matter. Because I’ll get to the most important part, which is how much exactly you should take out for a mortgage based on your income.

How Large of a Mortgage Should You Actually Take Out?

This is the most important part. It doesn’t matter what you can get approved for. It matters what you can afford.

Now, earlier I mentioned the possibility of building equity in your house simply by timing the market. You’re also building equity with each mortgage payment you make.

Is that a reason to go high? I don’t think so. The 28/36% is a pretty good measure to look at, but another aspect of all of this is that you really should be looking at your net income-not gross. What you actually bring home is all that matters at the end of the day, and this number is usually quite a bit less than what your gross pay is.

All of that being said, I will say this. If you’re bad at saving money in the first place then building equity in your home may be a good way to improve your net worth.

In other words, the first thing people tend to pay each month is their mortgage. So if you have a $1,500 mortgage instead of a $1,200 mortgage it isn’t the end of the world. I mean honestly are you really going to be spending that other $300 like you should? Most people don’t take that extra $300 and invest it, they usually spend it on things they don’t need. In other words, whatever percentage of that extra $300 you’re paying towards principal is money you are investing by default.

Again, this is why a bigger mortgage for people who are less inclined to spend money wisely in the first place may not be the worst thing. That being said, there are other ways to build wealth outside of real estate. So instead of maxing yourself out each month with a high mortgage payment, the better option is to stop being ignorant about money, go with a lower mortgage, and invest the additional money you’re saving.

Creating discretionary income to invest in is one of the best things you can do to get on track financially. The lower your debt is the more you can invest.

Ok, all of that being said. How large of a mortgage should you actually take out?

Final Answer

Obviously, there are a million different variables we could take into consideration here, there is no right or wrong answer. But in my honest opinion, a general guideline is to stay within this area: 20%-35% of your net pay, if possible.

Notice I didn’t say gross pay. 20-35% of your bring home pay. Now, as I mentioned, you can pretty much get approved for basically double that amount. It doesn’t mean you should do it.

You may also be wondering why there is such a range? There are a lot of factors going in to play here. We spoke about total debt to income, without considering all of that this gives you a nice guideline to follow. If you have a lot of other debt then stay towards the bottom of this number. If you don’t you can go towards the top.

So let’s compare, for someone (or a household) that makes 80k a year, where would that put the number? Well, that depends on what they actually bring home after taxes, 401k, insurance, etc. This number could vary quite a bit. Let’s just use a general number of 70% bring home pay, bringing their net income to $4,666.66 per month. This means at the low-end a payment of $933 per month and a high-end payment of $1,633 per month.

Now, compare this to what lenders could approve you at and this number is going to be much lower than that. The truth is there is a reason that around 78% of Americans are living paycheck to paycheck. We’re simply living above our means.

Even when considering everything I spoke about earlier regarding building equity in your house. Even if you have no plans to invest in other things, there may not be many reasons to go above that unless it’s not possible in your location. Maxing yourself out can put you in a bad position financially.

Can you go above it? Of course, like I said you may even get approved close to double that amount! However, this is really limiting opportunities for you to invest elsewhere or to create discretionary income to live with less stress.

Can you go below this? By all means, if you can make it work, go for it, just know it isn’t necessary. What about you? Are you looking to purchase a new home? What amount compared to your income are you considering?

Do you already own your home? How does your budget compare to these numbers and do you have any insight regarding the budget range you bought at?

Let me know in the comments below!