How much house can I afford?
Buying a home is one of life's most exciting milestones. But as you start this journey, the big question you have to ask yourself is: How much should I spend on a house?
In this article, we’ll help you to answer this question so you make a sound financial decision and avoid future stress.
If you have no time to read the whole article, go straight to our Home Affordability Calculator to get a personalized estimate of how much home you can afford.
How Much Home Can I Afford?
Determining how much home you can afford involves a careful assessment of your financial situation to ensure you can comfortably manage your mortgage payments along with your other financial responsibilities.
Here are essential calculations and considerations that will help you set a realistic budget for your new home:
How Much House Can I Afford Based on My Monthly Income?
As a general rule, your monthly mortgage payment should not exceed 28% of your gross monthly income. This percentage is commonly referred to as the housing expense ratio or front-end ratio.
This rule includes the mortgage principal, interest, property taxes and homeowners insurance.
For example, if your gross monthly income is $5,000, you should aim to keep your total monthly housing costs at or below $1,400.
How Can I Calculate How Much Home I Can Afford?
Here’s a step-by-step guide to help you calculate how much home you can afford:
1. Calculate Your Earnings
To calculate your gross monthly income, divide your annual pre-tax income by 12. For example, if you earn $84,000 annually, your gross monthly income is $7,000.
This figure includes all income sources such as:
- Salary and Wages: Include your regular salary or hourly wages.
- Bonuses and Commissions: Account for any variable income, such as annual bonuses, sales commissions, or performance incentives. Averaging these over a period (e.g., the past year) can give a more accurate picture.
- Freelance or Side Gig Income: If you have additional income streams from freelance work, part-time jobs, or side gigs, include these as well.
- Investment Income: Consider any dividends, interest, or rental income. Consistent income from investments can enhance your borrowing capacity.
- Other Sources: Don't forget about alimony, child support, or regular financial gifts from family members.
If your income fluctuates, such as with seasonal work or freelance projects, calculate your average monthly income over a longer period, like the past two years, to smooth out peaks and valleys.
While it’s important to be cautious, you can make reasonable projections of future increases in income like from promotions to gain a more comprehensive view of your financial situation.
If you're self-employed, your income calculation involves additional steps. Lenders typically review your net business income (after expenses) rather than gross revenue. Prepare detailed financial statements, profit and loss reports, and recent tax returns to confirm your earnings.
2. Add Up Your Debts
Next, calculate your monthly non-housing debt payments, such as:
- Student loans
- Car loans
- Credit card payments.
Do not include variable expenses like groceries or utilities. For example, if you spend $600 a month on these debts, this will be used in the calculation.
3. Determine Your Housing Budget
Use the 28/36 rule to answer the question “how much house can I afford based on my salary?”:
- 28% Rule: Spend no more than 28% of your gross monthly income on housing costs.
- 36% Rule: Spend no more than 36% of your gross monthly income on total debt payments, including housing costs.
Using the 28/36 rule, you can calculate your maximum potential housing payment as follows:
- Calculate 36% of your gross monthly income to determine your total debt limit e.g., 7,000 × 0.36 = 2,520
Subtract your non-housing debt payments from this total to find your maximum housing budget e.g.,
- 2,520 - 600 (non-housing debt payments) = 1,920
This means you can typically afford to spend up to $1,920 per month on housing.
4. Use Our Home Affordability Calculator
Our home affordability calculator is a valuable tool that helps you estimate how much house you can afford based on your income, debts, and down payment.
Let’s break this down with examples to give you a clear picture of different scenarios:
- For a $300,000 home, with a 20% downpayment ($60,000), a 30-year fixed mortgage at 6%, your monthly payment would be approximately $2,024.
- For a $400,000 home, with a 20% down payment ($80,000), assuming a 6.5% interest rate on a 30-year mortgage, the monthly payment would be around $2,348, excluding taxes and insurance. Adding $500 for taxes and insurance brings it to approximately $2,848.
- For a $500,000 home, with a 20% down payment ($100,000), assuming a 6.5% interest rate on a 30-year mortgage, the monthly payment would be approximately $2,528. Adding $500 for taxes and insurance brings it to approximately $3,028.
While these are all hypothetical scenarios, these examples can give you a quick idea of what you’ll likely be able to afford.
5. Consider Your Financial Needs
While the 28/36 rule and affordability calculators provide a solid framework, you should also consider your overall financial picture. Some factors to take into account include:
- Other Financial Goals: You may need to allocate funds for other priorities such as retirement savings, education funds, or emergency savings.
- Variable Expenses: Ensure you can comfortably cover variable costs like maintenance and utilities without straining your budget.
- Future Income Stability: Consider the stability and potential growth of your income.
For first-time homebuyers, a practical approach is to compare potential mortgage payments to current rent payments to gauge affordability.
Factors that Affect How Much House I Can Afford
Here are various components that affect how much house you can afford:
Down Payment
The larger your down payment, the less you need to borrow, which can lower your monthly mortgage payments and potentially qualify you for a lower interest rate.
Making a larger down payment can also help you avoid private mortgage insurance (PMI), which is required if your down payment is less than 20%.
Here’s the minimum down payment you need for different loan types:
- Conventional loans: 3% to 5% options available
- FHA loans: 3.5%. option available
- VA and USDA loans: may offer 0% down payment options.
Income
Lenders will consider your gross monthly income, which is your income before taxes and deductions, before approving you for a mortgage.
To verify your income sources, they will require:
- Pay stubs
- Tax returns
- Bank statements
- Any contracts or agreements related to freelance or rental income.
Debt-to-Income Ratio (DTI)
The debt-to-income (DTI) ratio measures your monthly debt payments against your gross monthly income. There are two types of DTI ratios:
- Front-End Ratio: This ratio considers only your housing expenses.
- Back-End Ratio: This ratio includes all monthly debt payments (housing expenses plus other debts), often set at 36% of your gross income.
Qualified mortgage standards allow for DTIs up to 43%.
Property Taxes
Property taxes vary by location. They are often included in your mortgage payment through an escrow account.
To estimate your property taxes, check online property listings or contact your local tax office.
Typically, property taxes are about 1% of the home's value annually.
Insurance
Homeowners insurance is mandatory for mortgage approval and protects your property against risks like:
- Fire
- Theft
- Natural disasters.
The cost of insurance varies based on the home's location, value, and features. To estimate insurance costs, you can ask for quotes from insurance companies or inquire with a Realtor who can provide an estimate based on similar properties.
HOA Dues
If your property is part of a homeowners association (HOA), you’ll need to pay monthly HOA dues. These fees cover the maintenance and upkeep of common areas and amenities. HOA dues can vary widely, so it's important to factor these into your monthly housing budget. The average HOA fee in the U.S. is approximately $191 per month.
How Can I Start the Mortgage Process?
After understanding your home loan affordability, the mortgage process comes next. Here is what we offer to support you through this process:
Our Mortgage Payment Calculator provides an instant, customized estimate of your future mortgage payments, breaking down:
- Principal
- Interest
- PMI
- Property taxes
- Insurance
- HOA fees
By using our calculator, you can explore different scenarios, adjust variables, and see how changes in loan terms and interest rates impact your monthly payments.
This transparency empowers you to make informed decisions and find a mortgage that fits your lifestyle and budget.
Next is getting pre-approved. Our Digital Mortgage Application streamlines this process, allowing you to complete it online at your convenience.
Within minutes, you'll receive pre-approval and a clear understanding of your home affordability options. This pre-approval not only gives you a competitive edge in the housing market but also provides a solid foundation for your financial planning.
Additionally, our RateReduce Programs, such as the 2-1 Buydown and 1-0 Buydown, provide flexible options to lower your initial mortgage rate.
Home Affordability FAQs
1. How does my credit score affect my ability to get a mortgage?
A good credit score can significantly influence your mortgage interest rate and terms. Lenders use credit scores to gauge your reliability as a borrower. Generally, higher scores can qualify you for lower interest rates, saving you thousands of dollars over the life of the loan. Scores above 740 are considered excellent, while anything below 620 may make it harder to qualify for a mortgage.
2. What are closing costs, and how much should I expect to pay?
Closing costs are the fees and expenses paid when finalizing a mortgage. They typically range from 2% to 5% of the loan amount and can include appraisal fees, title insurance, attorney fees, and lender fees. It's important to budget for these costs in addition to your down payment.
3. What is private mortgage insurance (PMI), and when is it required?
PMI is insurance that protects the lender if you default on your loan. It is required if your down payment is less than 20% of the home's purchase price. PMI can add to your monthly mortgage payment but can be canceled once you have 20% equity in your home.
4. Can I use gift money for a down payment?
Yes, many lenders allow you to use gift money from family members for your down payment. However, you will need to provide a gift letter that states the money is a gift and not a loan that needs to be repaid. This letter must be signed by the giver and the borrower.
5. How does an adjustable-rate mortgage (ARM) work, and is it right for me?
An ARM offers a lower initial interest rate than a fixed-rate mortgage but adjusts periodically based on market conditions. This means your payments can increase or decrease over time. ARMs can be beneficial if you plan to sell or refinance before the adjustment period begins. However, they carry the risk of higher payments if rates rise.
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