Although mortgage lenders place limits on how much you can borrow for a home based on your income and other debts, it’s also crucial that you think about your budget and how much you can actually afford to pay each month. So if you’re wondering “How much house can I afford?” here’s what you need to know.
How to calculate how much house you can afford
1. Calculate your income versus expenses
Write down how much you earn each month. Depending on your situation, your only source of income may be from employment, or you may have multiple sources, such as income from self-employment, alimony, child support, Social Security income, or retirement income. While lenders look at your gross income to help determine how much you can afford, using your net pay will give you a more accurate picture of what you can afford each month.
Next, look at your spending over the past few months and calculate how much you have left in your budget. Then add that amount to what you’re currently paying for housing, and that’s the maximum amount you can afford to pay.
2. Estimate the cost of housing
Take a look at the cost of homes in your area and, using current market rates, calculate how much you would pay monthly for a mortgage. Be sure to factor in your down payment and closing costs to calculate the initial outlay and monthly payment.
Don’t forget that you will also have to pay property taxes and home insurance premiums, which are usually added to your monthly mortgage payment. You can research property tax rates and average insurance premiums in your area to determine how much it might cost you.
If your down payment is less than 20% on a conventional loan or you have an FHA or USDA loan, be sure to also factor mortgage insurance or collateral fees into your estimate.
3. Check your credit score
Your credit score has a big impact on your mortgage interest rate, so it can influence the price of the house you can afford. If your credit score is less than excellent, you might want to take the time to work on improving your credit before applying for a mortgage. To qualify for a conventional loan, you generally need a credit score of at least 620, but it’s best to have a score in the mid-700s or higher if you want to qualify for the best rates available.
4. Determine your DTI ratio
Your debt-to-income ratio (DTI) is a key factor that lenders use to determine how much money you can borrow. If it’s too high, you may have difficulty buying the home you want. In this case, it’s a good idea to work on paying off the debt before applying for a mortgage. Use a DTI calculator to get an idea of how much of your gross monthly income goes to paying off your debts.
5. Use a calculator
You can do the math on your own, but if you’re hoping to save time and get an accurate picture of your financial situation, consider using a how much house can I afford calculator to work out the numbers for you.
How much should I spend on a house?
There is no single answer to this question. Mortgage lenders have DTI thresholds and will not allow you to borrow more than a certain amount based on your income and debt repayments.
The standard DTI rule to consider is the 28/36 rule. This means that no more than 28% of your gross monthly income should be allocated to housing costs, and no more than 36% of your income should be spent on total debt repayment, including housing costs.
For example, if your gross income is $5,000 per month, your housing payment should not exceed $1,400 and your total monthly debt payments should be less than $1,800.
That said, some lenders will allow you to go higher – the maximum you can do with a conventional loan is 50%.
However, just because your monthly payment is below the threshold set by a lender doesn’t mean that’s the amount you should be spending. Look at your budget and other financial goals to help you figure out what you’re comfortable with. If you max out your housing budget, you could run into financial problems later on.
How to afford more house
Depending on your situation, there might be ways to afford a more expensive home without putting your financial health at risk. These include:
- Make a larger down payment. Taking longer to save a larger down payment will reduce the amount you need to finance, which will lower your monthly payment. You might even qualify for a down payment assistance program, so do your homework to see what’s available in your area.
- Improve your credit. One of the best ways to lower your interest rate and therefore your monthly payment is to increase your credit score. Check your credit score and report to see where you stand, identify areas where you can make improvements, and then take action to fix them.
- Pay other debts. You can lower your DTI ratio and increase your cash available for housing by paying off existing debt. With credit card debt, you can consider using a balance transfer credit card or consolidation loan to help you reach your goal, or you can simply use the snowball or debt avalanche approach. .
- Compare the prices. Each mortgage lender has their own way of determining closing costs and interest rates, so shop around and compare quotes from several lenders before choosing one.
- Adjust your budget. Look at your expenses and see if there are any areas where you can permanently cut back to make more room for your dream home. Remember, once you reallocate that money to a monthly mortgage payment, you can’t continue to spend it on other things, so be reasonable with your budget cut.
As you take these and other steps to get your financial house in order, you’ll be in a better position to buy the home you want.
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