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How Much House Can You Afford?

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Published
01/19/2022

Whether you’re in the market for a starter home or you’re searching for a more luxurious and spacious forever home, your budget is critical to all the decisions you make. While everyone’s budget may be different, figuring it out ahead of time will guide your entire home search.

The following are things to keep in mind as you figure out and decide how much house you can afford.

 

Getting Started

A house is probably going to be the biggest purchase you ever make.

With that in mind, start with the basics. Your budget should begin by assessing how much you and your partner or co-borrower earn every month. As you’re calculating this, consider all of your revenue streams. This might include money from a side hustle, alimony, or investment profits.

From there, you can list what your estimated housing costs will be and the total down payment you can afford.

When you’re estimating your housing costs, you want to think about your property tax, mortgage interest rate (estimate this), loan terms, and homeowners’ insurance costs.

Once you’ve calculated this, you can look at your expenses. You need to know how much goes out every month because this is a big part of how much you can reasonably afford when you buy a house.

 

The 28/36% Rule

Once you have the numbers in front of you, you might think about following the 28/36% rule. The idea here, which many financial professionals recommend following, is that you don’t spend more than 28% of your gross income on house expenses. You shouldn’t, under this rule, spend more than 36% on total debt. Total debt can include credit card payments, student loans, and what you pay for your car loan.

This rule tends to be one that works well for most people as they determine how much house they can afford.

 

Factors Lenders Consider

When you apply for a mortgage, your lender will have its own criteria for affordability.

The factors that they may use to determine not only how much of a loan they’ll extend to you but also what the terms will be include:

  • Your gross income. Gross income is how much money you make before taxes, and other obligations are taken out of your pay. Most lenders will calculate gross income as your base salary, plus bonus income. Your gross income may also include self-employment, Social Security benefits, disability, alimony, child support, and part-time income you earn.
  • The front-end ratio. The front-end ratio is also known as your mortgage-to-income ratio. The ratio is the percentage of your yearly gross income that you can put toward paying your mortgage every month. Your monthly mortgage payment will include your principal, interest, tax, and insurance. This is sometimes referred to as PITI. Your PITI shouldn’t be more than 28% of your gross income, as we touched on above. Some borrowers will let you go beyond 30% or even 40%, but this doesn’t mean it’s a good idea to do so.
  • Your credit score. Credit score is a big factor in what lenders will be willing to extend to you in terms of financing. When you’re figuring out how much home you can afford, consider two broad elements. The first is income. The other is debt. Debt relates to your credit score. Mortgage lenders have a formula they use to determine how risky you might be to them if you were a prospective homebuyer. The formula can vary in specifics but is generally calculated using your credit score. If you have a low credit score and a lender is willing to give you a mortgage, you can expect to pay a higher interest rate.
  • Down payment. Your down payment is what you’re going to pay out-of-pocket when you buy a home using cash or perhaps liquid assets. Your down payment will usually be around 20% of the purchase price of the home, but many lenders will let you buy with a smaller percentage. Some types of loans don’t require any down payment.

 

If you’re a homebuyer, you have to be smart when it comes to affordability. Having a home that you can technically afford but that stretches you thin financially will affect most other areas of your life and your entire quality of life. Just because a lender tells you can afford something doesn’t mean you really can when you look at your finances and your life.

You have to be careful because lenders will look primarily at your gross pay and debts, but that doesn’t necessarily paint a full picture of your finances.

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