How Much Home Can You Afford?
Understanding how much house you can afford is the first step to successful homeownership.
Buying a house can be both exhilarating and a little overwhelming, especially when you’re figuring out how much you can comfortably afford. But figuring out your homebuying finances doesn’t have to be rocket science.
These guidelines can boost your confidence and your know-how, so you can find a home that’s a perfect fit for your budget and your lifestyle.
Key Factors That Determine Affordability
Let’s start with the basics. There are several factors that can determine how much you can afford to spend on your home:
- Income: Your (and your co-borrower’s) annual income before taxes is key to determining what you can afford.
- Debts: This includes car payments or student loans. Don’t include rent or current mortgage payments. Tip: Paying off debts can help you reduce your mortgage rate and monthly payments.
- Credit Score: This is crucial to determining your mortgage rate. Tip: Check out our tips on credit scores and how to improve them.
- Down Payment: Bigger down payments can make monthly mortgage payments more affordable. Tip: Read our article on how to save for a down payment.
- Mortgage Interest Rate: Credit score, down payment and even location determine this. Tip: Learn more about what goes into a mortgage payment.
By doing a little homework upfront to understand these factors, and taking steps where possible to optimize them, you’ll be on your way to finding an affordable home.
Next, you’ll need to take a deep dive into your current financial situation and your budget to gain a realistic idea of what you can afford.
Budgeting Rules of Thumb
There are different schools of thought about calculating how much home you can afford.
Some sources recommend that your total mortgage payment, including taxes and insurance, should not be more than 25 percent of your total income before taxes.
In general, lenders recommend the “28/36” rule, i.e., that you should spend no more than 28 percent of your gross monthly income on total housing costs, and no more than 36 percent on your total debt, including housing, credit cards, student loans, car payments, etc. This percentage—your total monthly debt divided by monthly gross income—is commonly known as your debt-to-income (DTI) ratio. To get a better understanding of your debt-to-income ratio, these guidelines can help.
Testing Out What’s Best for Your Lifestyle
Another commonsense approach is to look at how the costs of home ownership will fit into your overall financial goals, budget and lifestyle, and putting them to the test.
As a starting point, try to develop an estimate of what your new home ownership costs might entail, including your monthly mortgage payments, homeowners’ insurance, property taxes, utilities, maintenance and potential repairs. Check out this article to gain a deeper understanding of the hidden costs of homeownership.
Next, try to determine in real life whether you can easily handle adding these new homeownership costs to your general monthly budget combined with any anticipated future costs, such as getting a new car or starting a family. For instance, if you expect to spend an extra $1,500 each month on home-related costs, try putting that amount into a separate account where you can’t touch it. If you can live on $1,500 less a month, while living comfortably and meeting your other financial goals and obligations, you may have found a mortgage that’s a good fit.
Finding Just the Right Home for Your Budget
Once you’ve determined a range for what your budget can handle, it’s time to explore your options! Checking major real estate websites is a great way to familiarize yourself with what’s available in your price range and where to look. A trusted real estate agent also can guide you to the types of homes and neighborhoods that are within your ballpark budget.
After you’ve found the perfect place that meets your budgetary and lifestyle needs, you can take the next step by submitting your purchase offer.
You’re on your way to achieving your goal of homeownership!
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