How Do You Calculate How Much House You Can Afford?
When you start looking to buy a house, you’re probably considering factors such as size, location and proximity to schools. But perhaps the main question you should be asking yourself is: “How much house can I afford?” Here’s how to determine your home buying budget based on your financial situation.
Key Takeaways:
- To determine how much house you can afford, consider your monthly income, existing debt, credit score, cash reserves and expenses.
- The type of mortgage you choose and its interest rate also directly impact how much of a monthly payment you can afford.
- You can increase the amount of home you can afford by saving up to make a larger down payment, boosting your credit score, or adjusting your search.
Factors Affecting How Much Mortgage You Can Afford
It’s critical to know how much money you have available to spend so you don’t take on a mortgage you can’t afford. Keep in mind that the amount you think you can afford may differ dramatically from the amount that mortgage lenders determine. Knowing your potential monthly mortgage payment and how it will affect your budget is essential.
The easiest way to figure out how much you can afford to spend on a home is to use our home affordability calculator. But it’s also important to understand how the calculator uses your finances to determine its results. Let’s look at some key factors to consider when determining how much you can afford for your monthly mortgage.
Your Income
If you’re applying for a mortgage, your gross income – or “gross pay“ – is key to understanding how much you can afford. Gross income is the total earnings a person makes before deductions and taxes. Mortgage lenders and property owners look at gross income as an indicator of your financial reliability.
“A traditional rule of thumb is that you can usually afford a house that costs two to three times your annual income,“ says Eric Croak, a Certified Financial Planner and President of Croak Capital in Toledo, Ohio. “So, if you make $100,000 a year, you could typically afford a house priced between $200,000 and $300,000.“
However, Croak warns that this approach does not account for your monthly expenses and debts, which also significantly affect how much home you can afford.
Your Credit Score
Your credit score, which typically ranges from 300 to 850, shows how well you handle debt and how likely you are to repay a loan on time. Lenders usually set minimum credit score requirements for potential borrowers, which differ based on the type of mortgage you’re seeking. It’s simple: The higher your score, the easier it’ll be for you to qualify for a lower interest rate on a mortgage.
Your DTI Ratio
Lenders typically calculate an applicant’s debt-to-income ratio to determine how much home buyers can afford. Your DTI ratio divides your existing monthly debt payments by your gross monthly income.
Categories of debt include:
- Credit card debt
- Alimony
- Student loans
- Car loans
- Personal loans
- Child support payments
- Home equity lines of credit
Lenders calculate your DTI ratio to ensure you can comfortably afford the monthly payment once you get a mortgage.
Croak recommends building a family budget that includes all your monthly bills to get an accurate picture of how much debt you owe each month.
What Is The 28/36 Rule?
The 28/36 rule is a shorthand way to determine how much house you can afford based on your debts and expenses. The rule essentially holds that you shouldn’t spend more than 28% of your monthly pretax income on your mortgage payment. And when you factor in other expenses – such as a car loan, student loans or credit card payments – your mortgage and debts combined shouldn’t exceed 36% of your gross income each month.
For example, say your household brings in $10,000 every month in gross income. Multiply your monthly gross income by 0.28 to get a rough estimate of how much you can afford to spend a month on your mortgage. In this situation, you shouldn’t spend more than $2,800 on your monthly mortgage payment. Then, calculating your other costs shouldn’t take you above 36% of your pretax income – or $3,600 total in this case.
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Your Savings
Buying a home comes with certain upfront costs, as well as recurring costs. One of the most significant barriers to homeownership is saving enough money to cover these expenses.
Down Payment
Your down payment is a percentage of the purchase price you pay upfront when you close on the home. You’ll typically need to make a down payment of at least 3% to get a conventional loan. You’ll need a down payment of at least 20% to avoid paying for private mortgage insurance.
Closing Costs
Closing costs are all the different settlement fees incurred during the home buying process before it’s finalized. They include appraisal fees, lender origination fees, underwriting fees and more. You can expect closing costs to amount to around 2% to 5% of the home’s purchase price.
Emergency Fund
It’s also important that your down payment and closing costs don’t completely wipe out your savings and that you still have enough left to cover any large or small financial emergencies that might arise. Lenders often want to see that potential buyers have cash reserves on hand. A 2024 Forbes Advisor survey found that roughly 28% of Americans have less than $1,000 in savings.
An emergency fund can keep you from falling into a difficult financial situation and can indicate to lenders that you’re ready to withstand economic woes.
Moving Costs
Once you close on the home and get the keys, you’ll have to cover the costs of moving. Be sure to factor in the cost of packing supplies and whether you’ll need to hire movers. The distance you’ll need to travel and the volume of your belongings will also affect the price. If you’re moving locally, you can expect to pay anywhere from $900 to $1,500 for a moving company, while a long-distance move of 100 miles or more can cost anywhere from $2,700 to $10,000.
Your Mortgage Type
There are several different types of mortgages that can help you find the best home financing option. Here, we outline the main four so you can understand the benefits and differences of each type and decide what’s right for you.
Conventional Loan
A conventional loan is provided by private lenders and not backed by a government agency. It can be conforming, meaning it meets specific standards set by the Federal Housing Finance Agency and can be sold to Fannie Mae or Freddie Mac by the lender. Or it can be non-conforming, which means the lender sets the terms. Non-conforming loans that exceed the FHFA limit are commonly known as jumbo loans.
The down payment for a conventional loan can be as low as 3%, though putting down less than 20% means you’ll have to pay for PMI. While conventional loans have stricter requirements to qualify, they typically lost less than FHA loans.
FHA Loan
A Federal Housing Administration loan is for borrowers with low to moderate income, and has a lower credit score requirement than conventional loans. FHA loans require you to pay both an upfront mortgage insurance premium and an annual mortgage insurance premium.
VA Loan
Veterans Affairs loans are for military service members, veterans and their qualifying spouses. VA loans also do not require a down payment, and nearly 90% of VA loan borrowers put no money down on their homes. VA loans also have no minimum credit score, but your lender may have its own requirement based on your financial situation. If you default on your loan, the VA will pay back a portion of the loan to the lender. Borrowers are required to pay an upfront VA funding fee.
USDA Loan
A U.S. Department of Agriculture loan – also known as a rural development loan – helps low- and moderate-income borrowers buy a home in specific rural areas. USDA loans require no down payment, but borrowers must pay an upfront guarantee and annual fees.
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Your Interest Rate
Your interest rate represents the cost of borrowing your home loan and is expressed as a percentage. The rate you’re charged will directly impact your monthly payment and the overall amount you pay for the loan.
Another factor that affects affordability is whether your interest rate will change. If you have a fixed-rate loan, your interest rate is set when you take out the loan and never changes. With an adjustable-rate mortgage, your interest rate will adjust occasionally due to market changes after an introductory fixed period. If your interest rate increases, so will the amount you owe each month on your mortgage.
Your Loan Term
The term on your loan also affects how much house you can afford. Generally, loans with longer terms have a lower monthly payment because you take more time to pay off your loan. You’ll typically pay a higher interest rate and more interest overall. Loans with shorter terms have a higher monthly payment, but a lower interest rate and less overall interest.
Property Taxes
Property taxes are assessed by state and local governments on land and buildings to pay for community services like public schools, law enforcement and infrastructure – services you typically benefit from as a homeowner. Property tax rates vary widely from state to state.
Homeowners Insurance
Homeowners insurance protects your home and property in case of losses or damage. Lenders require you to have sufficient insurance, and you’ll often pay property taxes and homeowners insurance through an escrow account as part of your monthly payment.
HOA Fees
If your home belongs to a homeowners association, you must pay HOA fees to cover shared amenities and services, like trash pickup and landscaping. The fees vary greatly based on the type of home and community you live in, but you can expect to pay an average of $200 to $300 a month.
Maintenance And Repair Costs
When you own your home, you’re responsible for all maintenance and repairs. Financial experts recommend setting aside 1% to 2% of the current value of your home each year to pay for repairs.
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Ways To Increase How Much Home You Can Afford
If the home you want is beyond your budget, all hope is not lost. Here are some ways you can increase the amount of home you can afford to buy:
- Save a larger down payment. Making a larger down payment means you need a smaller loan, which results in lower monthly payments. A larger down payment also can help you score a lower interest rate and avoid paying for PMI.
- Boost your credit score. Improving your credit score is another way to get a lower interest rate on a mortgage. You can work to boost your credit by paying your bills on time, catching up on past-due accounts, and paying down your debts.
- Adjust your home search. If you want to buy a bigger home but can’t afford one where you’re looking, expand your search to more affordable areas.
- Increase your income. If you can earn a promotion or a raise, or take on a side hustle, it can help you get approved for a larger mortgage.
- Pay off debts. If you reduce your debt and lower your DTI ratio, lenders are more likely to approve you for a larger loan or lower interest rate. “Debt consolidation might also be a good idea, especially if it can save you money by combining your debts into a single, more manageable payment,” Croak says.
FAQ
Here are answers to some frequently asked questions about figuring out how much house you can afford.
The Bottom Line
Purchasing a home is quite possibly the most significant financial step you’ll take in your life, so it is crucial to do your due diligence and determine how much house you can afford. Look at factors like income, DTI, savings, mortgage type, interest rate and expenses to make the most informed decision for your budget.
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Sam Hawrylack contributed to the reporting of this article.
