How Much Home Can I Afford?

Starting your journey to homeownership is a thrilling endeavor, especially when you are confident in your ability to tackle the costs. However, knowing that you are financially ready to buy a house is different from understanding exactly how much home you can afford.

The first step you will need to take as you begin your homebuying process is establishing a reasonable budget. There are a number of factors to keep in mind, but the good news is that there are equations and online tools you can use. After reading this article, you will hopefully better understand how to outline your homebuying budget and should have a general idea of how much mortgage you can afford.

How much mortgage can you afford?

While you will not know exactly how much mortgage you may be approved for until your lender gives you a pre-approval letter, you can use online mortgage calculators to get started with some estimates.

A home affordability calculator only needs a few pieces of information, starting with your annual income. If you are purchasing with a joint borrower or combining assets, use the total income for all parties involved. You will also need an estimate of your recurring monthly debts, including all credit cards, car payments, and overall monthly outgoing bills. Determine what you might be able to provide for a down payment, the term of your loan (for example, a 30-year mortgage), and potential interest rate. The calculator will quickly provide a range of what you are likely able to afford based on the information you provide.

Once you have an estimated range of affordable home prices, you can also use a mortgage payment calculator to estimate how much your monthly mortgage payments may total.

How much house can you afford based on salary?

Your salary is an important component of determining how much home you are able to afford. But it is only one piece of the financial puzzle that your lender will use to gauge your mortgage eligibility. However, it will be important to consider how much of your salary you are willing to dedicate to the expenses of homeownership prior to committing to the responsibility.

Expert advice points to the 28/36 percent rule as the standard for determining the affordability of buying a home. This rule dictates that no more than 28% of your gross monthly income should be spent on your overall housing expenses (including your mortgage payments, monthly bills, and mortgage insurance). On top of this, your total debt should not exceed 36% of your monthly income. The remaining 36% percent is then yours to use and budget as you wish.

While you will not know the exact total of housing expenses at the start of your homebuying journey, you can begin to calculate your total debts and understand how they affect home affordability.

What is DTI?

DTI stands for debt-to-income ratio. This is an equation that calculates all your monthly debt payments, including your proposed housing debt, and compares it relatively to your pre-tax income. Here is an example of how to calculate your DTI ratio:

• Total monthly pre-tax income = $4,000
• Total monthly debt payments including mortgage, taxes, and insurance = $1,140
• Your DTI is $1,140 divided by $4,000 = 0.285 or 28.5%

Most lenders will require that your DTI ratio is equal to or less than 43% in order to be approved for a mortgage. However, keep in mind that this percentage may also affect the interest rate you qualify for, so in some cases it can be better to work on paying down other debts prior to buying a home. Another factor that will affect the overall affordability of a home purchase is the amount you provide for your down payment.

How much of a down payment do you need?

There are several ways to answer this question. Typical guidance is a 20% down payment if you can afford it. However, on a $250,000 home purchase, that means you would need $50,000 for the down payment, and you may still need another 2% to 6% for closing costs.

Let us examine down payment needs across a few different loan types to better understand what you can afford. You should note that while typical guidance is a high down payment, as it lowers a lender’s risk to loan you money, most lenders have down payments in the 3% to 5% range. Or, if you are eligible for a VA loan, no down payment is required.

Conventional loan

Despite the common recommendation of saving for a 20% down payment, you may be able to get a conventional loan by putting down as little as 3% to 5%. However, if you have a down payment of less than 20%, you will need to have private mortgage insurance (PMI), which is a monthly cost incorporated into your home payment. Here are the potential costs for a $250,000 home with a conventional loan:

• 5% down = $12,500 down payment
• Closing costs between 2% and 6% of the purchase price
• Monthly PMI payment

VA loan

One of the biggest benefits of VA loans is that they typically require no down payment and generally offer better rates. Here are the potential costs for a $250,000 home with a VA loan:

• Require that the down payment may be as low as $0
• Closing costs generally between 2% and 6% of the purchase price

FHA loan

FHA loans can require as little as a 3.5% down payment, but will also require MIP (mortgage insurance premium). With MIP, you may have to pay an up-front and annual mortgage insurance premium. With MIP, you could be paying additional insurance payments for years until you have built up enough equity in your home, or possibly for the life of the loan. The potential costs for a $250,000 home with an FHA loan:

• 3.5% down = $8,750 down payment
• Closing costs between 2% and 6% of the purchase price
• Up-front and required ongoing MIP payment

What are the total costs of homeownership?

It is not uncommon for a financial institution to inform you that you can afford more than you thought you could. Before looking at the bigger, more expensive home, fully understanding the total cost of homeownership is important.

A monthly mortgage payment is only part of buying a home. You may need money for a down payment on your home, as well as closing costs, property tax payments, insurance, possibly private mortgage insurance (PMI), and more. Here are some additional expenses you may want to consider as you are budgeting for homeownership:

• Homeowners association (HOA) fees
• PMI or MIP—may be an expense if you do not have a VA loan and put down less than 20%
• Utilities
• Trash collection
• Appliances and repairs
• Roofing care
• Pest control
• Yard care and tools
• Heating, ventilation, and air conditioning (HVAC)

Research mortgage lenders

When it comes to buying a home, it is vital to understand what you can afford before you jump into the process. Mortgage calculators are a great resource to start with when it comes to outlining your homebuying budget, but do not hesitate to reach out to lenders for their insight as well. Choosing the right mortgage lender can help set you up for a more seamless homebuying experience. That is why it is important to do your research and compile a list of lenders to start contacting. You can ask them questions and gain insight into the types of mortgages they offer.

The right lender should be able to walk you through your mortgage options and help you determine what makes sense for your unique situation.