Homes come in every size, style and price range. Knowing what you can afford at the beginning of your search saves you time and disappointment later on. The following calculations outline the process financial institutions use to determine what you can afford.

Lenders such as banks and trust companies allow you to spend approximately 32%* of your gross monthly income on housing costs (including property taxes, heating, and, if applicable, 50% of condominium fees. The ratio of debt to income is referred to as the Gross Debt Service ratio or GDS.
* Please note that many lenders are prepared to exceed these guidelines.

The second affordability rule is that your entire monthly debt load shouldn't be more than 40% of your gross monthly income. This includes housing costs and other debts, such as car loans and credit card payments. Lenders add up these debts to determine what percentage they are of your gross household monthly income. This is your Total Debt Service (TDS) ratio.

In addition to GDS and TDS ratios, financial institutions base their lending decision on your credit history, job stability and the amount of your down payment. Interest rates also affect the amount of financing you will be able to obtain.

David earns $40,000 annually and his partner Ruth earns $43,500. They have a car payment of $350 per month and a credit card payment of $150 per month.

How much can they afford monthly for housing?

David's monthly income                $3,333

($40,000 divided by 12)
Ruth's monthly income)                $3,625
($3,500 divided by 12)      
Total                                               $6,958
GDS ($6,958 x 32%)                  $2,226.56

They can afford to spend no more than $2,226.56 on monthly housing costs. How much can they afford with their other monthly payments?

Monthly Debts
Car Payment                                   $350
Credit Card Payment                      $150
Monthly Housing Cost            $2,226.56

Total                                        $2,726.56
TDS                                                  39%
($2,726.56 divided by $6,958)

Because their total debt including housing costs and all other monthly debts does not exceed 40%, they can afford to purchase a home.