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In purchasing a home, I have read that a good rule of thumb is the cost should not exceed 2 1/2 times one's salary.  Is that cost the mortgage size or purchase price of the home?  It seems like it would be the mortgage size, but we will be buying our first home and there may be hidden costs that we are unaware of that would make this rule apply to the price of the home.

Thanks to all who respond.

    The rule of thumb, which prevailed in the 60s and 70s, was a mortgage at 2.5 times income after a 20 percent down payment. If you visit any of the "How much house can I afford?" calculators you'll find that the multiple has been inflated along with house prices. Unfortunately, the rule of thumb is to provide reasonable security for the lender. It is NOT based on your ability to buy food or make regular investments in your company 401(k) account.

Scott 

Elaborating on what Scott just wrote:

Many people will qualify for a mortgage loan on a house worth about 2.5 times their total (gross) annual income assuming a 20% down payment and a moderate amount of other long term debts (student loans, car payments, etc.) HOWEVER……..           

Whether you can really AFFORD this much house is another matter entirely. Even if the bank is willing to give you the loan, can you weather a financial crisis such as the loss of a job or illness? If the answer is NO, then you are taking a big chance since there is no guarantee that you will be able to sell the home for what you paid for it. Right now housing prices are going down in many parts of the country – even California which has been a hot market for many years.

Historically, mortgage companies required that all monthly payments would be no more than 28% of your monthly income (in addition to making a down payment of at least 20%). The whole Subprime mess came about partly because loans were made ignoring the traditional guidelines to allow more people to qualify. They were also qualified on the basis of low “teaser” rate on adjustable rate mortgages. When the rate adjusted they could no longer afford the payment. This is particularly bad when interest rates are rising since the mortgage rate is usually based on some type of interest rate benchmark. When housing prices have declined, the homeowner can’t refinance or sell the house to get out of trouble.

The fallout of the Subprime mess is that even creditworthy individuals are having a harder time qualifying for a loan. Loans conforming to traditional guidelines are still available because the bank can sell those loans to Fannie Mae and Freddie Mac. If the loan does not conform to guidelines, the loan has to be funded some alternative way. Those alternatives are very limited today making non-conforming loans increasingly scarce.

There are many website calculators to help you determine mortgage payments. For example: www.quickenloans.quicken.com , www.quickenloans.quicken.com and many of the larger mortgage lenders.