How Much House Can I Afford?
Have you ever thought about how much house you can afford? Maybe you have a number in mind, but have you ever compared it to a home affordability calculator?
Sometimes, the amount we think we can afford is different from what mortgage lenders think. Knowing well ahead of time what you can afford and how it will affect your budget is important.
Here’s everything you must know about home affordability.
How Much Can I Afford For A House?
Buying a house is one of the largest financial purchases you’ll ever make. But, before you do, understand how much you can afford so you don’t get in over your head in debt.
Knowing how much you can afford means being realistic about how much you make and your current and potential future debts. You must consider unexpected expenses and occurrences and how your life might change in the future.
A good rule of thumb when thinking about ‘how much house can I afford’ is the 29/41 rule. Of course, you don’t have to follow it exactly, but it’s a nice guide to figure out how much house you can afford.
The two numbers signify where your debt ratio should be to make your mortgage affordable.
The first number is for your total mortgage payment and is called your housing ratio. Your housing ratio shouldn’t exceed 29% of your gross monthly income (income before taxes). If applicable, your total mortgage payment includes the principal, interest, real estate taxes, homeowner’s insurance, homeowner’s association dues and mortgage insurance.
In other words, it focuses on the cost of owning a home and compares it to your gross monthly income. Focusing on this area helps you avoid becoming ‘house poor’ or having buyer’s remorse.
Here’s the formula:
Principal + Interest + Monthly real estate taxes + Monthly homeowner’s insurance + Monthly HOA dues + Mortgage insurance
____________________________________________________________________ x 100
Gross monthly income (income before taxes)
For example, say your total housing costs for a month is $1,200. Your gross monthly income is $4200. You would divide 1,200 by 4,200 to get 0.29 (rounded up). Multiply this by 100 and you have a 29% housing ratio.
Your housing ratio shouldn’t exceed 29% for the best results. Not only will this help you get approved for more loan programs, but it will ensure that your mortgage payment is affordable given your income.
The second number refers to your total debts, including the new mortgage payment plus any other consumer debts you have, such as credit cards, personal loans, car loans, child support/alimony or student debt. Most people go into homeownership with at least some debts, but you should do so with caution.
Ideally, your total debts shouldn’t exceed 41% of your gross monthly income for affordability purposes. Some loan programs allow a higher DTI, but it becomes harder to afford your mortgage payment if you do. Always compare the total payments to your current budget to see how things stack up. Just because you’re approved with a higher DTI doesn’t mean it’s affordable for you.
*Note that you can use the minimum required payment for any revolving debt (credit cards) in this calculation.
Here’s the formula:
Total monthly debt payments
___________________________________________________________________ x 100
Gross monthly income (income before taxes)
So, say you pay the $1,200 a month mentioned above, plus an additional $500 in debt for a car payment and student loans. You divide 1,700 by 4,200 to get 0.40 (rounded down). This means your DTI is 40% with your mortgage payment.
Now, is it okay if your total DTI exceeds 41%? In some cases, yes, but keeping it at 41% can mean a more affordable mortgage payment and may allow you to have better rates and terms.
Mortgage Affordability Calculator
Figuring out how much house you can afford can feel overwhelming, but if you use our home affordability calculator, you can determine how much home you can afford. You can also see how much money you need for the down payment and closing costs to get the loan.
The nice thing about the mortgage affordability calculator is that you can play around with the numbers to find the payment that fits in your budget and the overall amount you can afford.
Determining Your Debt-To-Income Ratio
Your debt-to-income ratio is one of the most significant factors for applying for a mortgage. Mortgage lenders look at this after checking your credit score to ensure it fits within the program’s guidelines.
As we described above, they look at two debt ratios: Your housing ratio and your total debt ratio. Your housing ratio focuses only on the payments that pertain to the house or mortgage payment. However, your total debt ratio includes any other payments you have (that report on the credit report) and is the number that determines if you qualify for the mortgage.
Some common debts included in the DTI include:
- Minimum credit card payments
- Student loan payments
- Personal loan payments
- Car loan payments
- Child support
- Any other payment arrangements
If your DTI is too high compared to what a loan program allows, you can reduce it by paying off debts or finding ways to increase your income. For example, if you have a large amount of credit card debt, you can pay the debts down to lower your minimum monthly payment and your debt-to-income ratio.
You could also pay off installment debts so that they are eliminated from your debt-to-income ratio altogether.
Remember that the fewer debts you have when applying for a mortgage, the easier it is to afford this critical investment.
Other Home Affordability Factors To Consider
As you explore the answer to ‘how much house can I afford,’ you should consider a few other factors to make sure you are comfortable with the payment and the total cost of buying a home.
Many factors go into a mortgage payment and analyzing them upfront can help you determine what’s affordable for you.
Adding a mortgage payment to your budget is a big change, especially if you haven’t paid rent yet. However, as lenders call it, the payment shock can be a risk of default if it’s too much.
It’s important to review your budget and track your monthly expenses to ensure you can afford the mortgage payment. You might even try taking the money out that a potential mortgage would cost for a few months to see how it feels in your budget.
A big part of your budget, even after you buy a home, should be savings. When you apply for a mortgage and can prove you have ‘extra’ money to cover your mortgage payments should you lose your job or have an emergency, it can help you get approved.
Some lenders call these cash reserves, and while it’s not a formal requirement to get approved for a mortgage, it can help you get better rates and terms. In addition, when lenders see that you have money saved for the unexpected, they know you’re at a lower risk of default and are more willing to lend to you.
It’s also important to focus on saving money for emergencies, whether unexpected home repairs or a job loss, to afford your bills throughout the emergency.
Note: Cash reserves are NOT your down payment. After you make your down payment and pay the closing costs, it's money you have left.
Loan Term And Interest Rate
Your loan term is how long you borrow the money for. Most first-time home buyers take a 30-year term, but there are other options too, such as a 15-, 20- or 25-year term. The lower the term, the less risk the lender takes, resulting in a lower interest rate.
Mortgage lenders base your interest rate on several factors, including your credit score and debt-to-income ratio. The more ‘good factors’ you provide, the lower the interest rate they can offer.
You can also choose between a fixed- or adjustable-interest rate. A fixed-rate stays the same for the entire term, and an adjustable-rate changes annually after the introductory period. Adjustable rates are often lower than fixed rates initially but may adjust annually.
Your required down payment can play a significant role in your home affordability. You might not need a 20% down payment as most people think. While a 20% down payment helps you avoid mortgage insurance, there are times when it makes sense to put down less.
If you aren’t planning on staying in the home for a long time, you could temporarily save the money on the down payment and pay the mortgage insurance. Since it’s not a long-term expense, you could invest your money elsewhere in the meantime.
If you’re worried about not having cash reserves or an emergency fund, making a smaller down payment may make sense too. Many loans offer as low as 3% down payment options, including conventional loans. Play with the numbers to see how a lower down payment would affect your payment to make sure it’s affordable.
Debt And Other Expenses
Before committing to a mortgage payment, make sure you have enough money to cover all of your debts and have disposable income.
If you’re going into homeownership with a lot of consumer debt, it could make it harder to afford your mortgage payment. Other payments you should consider are homeowner’s insurance, private mortgage insurance (PMI), HOA dues, property taxes and the typical credit card payments and other loan payments you should consider.
The Bottom Line
Before you answer the question ‘how much house can I afford,’ you should consider the many factors that affect it. Looking closely at your current debts, income potential and plans for the future can help you determine how much you can afford.
Sticking to the 29/41 rule can help you keep things affordable even when your circumstances change, and no matter what you decide, a real estate agent can help you through this process. So get started with Rocket Mortgage® to take the first step in your home buying process.