5 Reasons Banks Are Wrong about How Much House You Can Afford

Avoid Breaking Your Bank & Years of Financial Struggle

by Rob Bertman, CFA®, CFP® in Debt, Home buying
November 17, 2016

You’ve been really smart.

Seeing what happened to the housing market 8 years ago combined with having student loans has made you very cautious about making the leap to homeownership.  You just weren’t quite ready for it.

But now, maybe you’re thinking about taking that step.

You’ve gotten a little older and have started saving up a little money. The housing market has gotten more stable and mortgage rates are near all-time lows.

Perhaps you’ve started to think about what you want, number of bedrooms and bathrooms, what part of town, different features, amenities, and style.

Once we dream about what we want out of our potential house, we start thinking about how much house we can afford.

How Much House Can We Afford?

This is the most challenging and the most important part.  It’s a major financial decision!

So do you try to crunch some numbers on your own, search for an affordability calculator, or rely on someone else to help you figure it out?

The problem is that if you’re looking for unbiased help you can trust, your options are limited and hard to find.  Even if you find a way to figure it out on your own, most severely underestimate the full cost of owning a house.

Banks are tough for people to trust these days, and though real estate agents can help you find the right place, they’re not in the business of walking you through the financial piece.

How do most people figure it out?

Here are the 4 steps most people take.  After this, I’ll tell you about the life-changing flaws of this method:

  1. First, they Google “How much house I can afford?” and find a calculator or two that asks 3 basic questions:
    • How much money do you make a year?
    • How much do you have saved for a down payment?
    • How much are your monthly debt payments?
  1. Next, it’s time to go to Zillow or to start browsing around. At some point, they work with a referred real estate agent or friend in the business to find the right place for them.
  1. After searching for a few months, they start to crunch some numbers on their own but, like me, I underestimated the full cost of owning a home.
  1. Finally, they find a place and go to the bank to get pre-approved for the loan. The bank asks the same questions as the online calculator, and they’re off to the races!

Beware of this process!

It is missing absolutely crucial factors to determine if you can truly afford the house.

I know this because I’ve owned my own home for more than 6 years, helped clients plan for and execute home buying decisions, and have seen many friends take this step and share their stories about it.

This process makes people house poor, gets them into financial difficulty, leads to stress, arguments, and missing out on other fun experiences in life.

The only way out is to sell the house and downsize, go back to renting or build up credit card debt hoping to earn your way out of it.

So how are these calculations flawed in telling you how much house you can afford?

Here are the 5 reasons the bank’s calculation is wrong:

  1. Banks go by monthly payment, not the loan amount.

Ok, here’s the deal.  The bank just wants to see that your mortgage payment will be no more than 36% of your gross salary.

In other words, if you make $5,000 a month BEFORE taxes, they say you can afford a $1,800 mortgage payment. Pretty simple right?

Here’s why that calculation is flawed.

If rates move up to 7% like they last hit in 2002, you could get a loan for only $270,000.  But today, if you can get a 3.5% rate, you qualify for a $400,000 loan.

That’s $130,000 of extra debt!

That’s how much it could cost going to 4-year college all over again!

Why does it make sense that a bank’s “affordability” calculation doesn’t differentiate between an extra $130,000 of debt?

It doesn’t. Not one bit.

  1. Banks only look to see if you have enough money to cover the down payment.

A big benefit of buying our home is being able to put our own stamp on it without a landlord telling us what we can or can’t do.

Talking from personal and professional experience here, I have heard of absolutely no one spending $0 on improvements once they move into their new home.

Most people freshen up the look, do some remodeling, buy new furniture, decorate, take care of issues in the inspection report not negotiated in the contract, etc.

In fact, the average couple spends $10,000 on improvements in their first year of homeownership according to Zillow.

I’ll just go ahead and say it: That’s low compared to what I’ve seen in my 15 years in the financial industry, talking with friends, and going through this process myself.

The reality is that we need a bigger savings cushion than just being able to cover the down payment by AT LEAST $10,000.

  1. Banks look at your other debt payments and history, not the total amount of debt you owe.

This is not too far off from #1, but it is a little different because it involves other debt payments being made.

Lenders use this thing called a debt-to-income ratio.  They look at your current monthly debt payments then add the projected monthly mortgage payment, and it can’t exceed that 43%.

In other words, if you make $5,000/month BEFORE taxes, you can only have $2,150 in total debt payments including the estimated mortgage payment.

Here’s the kicker. For credit card debt, they only count the minimum payment amount toward that ratio which tends to be about 2% of the amount owed.

Now although each payment we make on our mortgage and student loans pays back part of the loan balance, the credit card balance will GO UP if someone is paying only the monthly minimum payment.

Doesn’t my credit score tell them how much debt I have?

No, the credit score factors in your credit utilization (the % of your total credit being used vs total credit available), but not the total amount.  It also gives them an indication of how often you make the minimum loan payments, but that’s it.

Again, they don’t take total debt into consideration.

Also, going back to point #2, it doesn’t account for the additional spending that will occur after buying the house. Someone could qualify for a loan just barely, then max out the remaining available credit on updating the house and furnishing it.

This type of planning can sabotage wealth creation and the ability to reach other financial goals.

  1. Banks don’t know your spending habits

Now that we know that banks are looking for total debt payments including your estimated mortgage payment to be 43% of your income, what are you doing with the other 57%?

Well about 20% of it probably goes to taxes.  That leaves 37% for everything else.  So what you do with that extra cash is critically important.

If someone is frugal in their everyday life and doesn’t spend very much money on food, travel, entertainment, cars, and kids if they have them, then they can afford a bigger house.

But most of us are saving a little bit or not at all, so we have very little wiggle room to keep up with the mortgage payment and the other costs involved in owning a home.

Here’s an interesting stat: The average homeowner spends $9,000 per year on utilities, maintenance, and improvements.

That’s $750 per month on average in addition to the mortgage payment!

For example, my wife and I recently had a tuckpointing issue and had to unexpectedly shell out $2,000 to fix the problem. (If you’ve never owned a home, you probably don’t know what tuckpointing even is.  I sure didn’t.)

My point is that we need to have extra dough on hand to pay for this stuff, because “this stuff” happens all the time. Just ask anyone who has owned a home for at least 3 years.

How much of a cash cushion you have on a monthly basis is really important, and the banks don’t advise people who take out a mortgage on it.

  1. Banks don’t consider your other goals and future plans.

Do you have plans to have a kid, start your own business, pay for college, or retire at a certain point?

Chances are you have one, two or more of these goals in mind and you’ve probably put at least some thought into the savings and future costs that go into that.

Let’s go with wanting to have a kid for example.

I have 3 of them and it’s so wonderful! I love my family with all my heart.

…but it’s also expensive.

There’s daycare which can be $10,000-$15,000/year for full time quality care (unless you live in New York), diapers, doctor visits (I call it Kid’s 3D Expenses) plus other costs.

You can afford a house now, but after having a kid or two, your childcare costs can actually exceed your mortgage payment.

Yes, that happened to us, and others I know.


Let me be very clear.

I’m not trying to scare you out of buying a house or having kids. Both can be truly wonderful life experiences and improve your quality of life.

The purpose is to help you understand that the bank’s calculation of how much house you can afford is extremely inadequate and severely underestimates how much house someone should buy.

This is a life-changing financial decision, and it requires some work if you want to avoid struggling financially and feeling stressed in your life and relationship.

PLEASE take these 5 factors into consideration before buying a house. Don’t rely on the online calculators or the bank’s estimate on face value!

My final observation

Many of you have expressed to me that it’s been difficult to find someone to help you work through the numbers in a comprehensive fashion.  Options are limited and in many cases biased and inadequate.

I’ve seen too many people make this major decision without having the guidance from an experienced, unbiased professional who has gone through all this stuff personally and helped clients work through it successfully.

Someone who could step in and help you out with just this one decision without having to commit to additional long-term planning and fees.

That’s why I began offering financial coaching specific to buying a home.

I help couples figure out how much house they can TRULY afford to buy taking all of the above factors into consideration so that they can avoid the financial stress and arguments that come from being house poor and overextended financially.