How Much House Can I Afford? How To Purchase Your Dream Home

Vault’s Viewpoint on Affording Your Ideal Home

• According to the 28/36 rule, you should spend no more than 28% of your gross income on a housing payment and up to 36% on all your debts combined.
• That monthly housing payment will need to cover your principal, interest, property taxes, homeowners insurance and any other recurring costs.
• Making a larger down payment and getting a low mortgage rate can help you afford more house.

How to Calculate What House You Can Afford

To calculate your housing budget, start by comparing your monthly earnings to your monthly debt payments. Then you’ll determine how much to dedicate toward a home loan payment.

1. Calculate Your Earnings

Add up your monthly income before taxes, which is your gross income. So if you earn $84,000 a year, for example, that breaks down to $7,000 a month ($84,000 / 12 = $7,000).

2. Add Up Your Debts

Figure out how much you spend each month on nonhousing debts, like loans and credit card balances. Don’t include other monthly expenses such as groceries, gas, current rent payments and car insurance. For our example, let’s say you spend $600 a month toward your consumer debts.

3. Determine Your Housing Budget

Some homebuyers use the 28/36 rule of thumb to determine their potential housing payment. This rule states you should spend no more than 28% of your gross income on your home-related costs and no more than 36% on total debts.

So if you earn $7,000 a month before taxes and spend $600 on other debts, here’s how you’d calculate your maximum potential housing payment:

Step 1: Calculate 36% of your total gross income. The result is how much you should be spending on total debts each month, according to the 28/36 rule.

$7,000 x 0.36 = $2,520

Step 2: Subtract your current nonhousing debts from the maximum outstanding debt you should have. The result is your maximum monthly housing payment.

$2,520 – $600 = $1,920

A mortgage affordability calculator can help you figure out your home price based on your monthly budget.

4. Consider Your Financial Needs

While the 28/36 rule can be a good starting point for determining home affordability, you’ll still want to take your entire financial situation into account when considering how much house you can afford.

Some homeowners set a smaller mortgage budget if they’re paying down nonhousing debt or want to put money toward other goals, such as long-term savings. And on the other hand, homebuyers without a lot of monthly expenses may feel comfortable dedicating a larger portion of their income toward housing payments.

If you’re a first-time homebuyer, consider using your rent payment to help gauge how much you can spend on housing each month.

Factors That Impact How Much Home You Can Afford

After setting an overall housing budget, you’ll need to consider what goes into your monthly payment. The amount you pay toward interest, property taxes and homeowners insurance each month will affect how much house you can afford. Other factors come into play as well.

Mortgage Rates

A portion of your monthly mortgage payment goes toward principal and interest. Generally, a low mortgage rate can help you afford a higher-priced home because it frees up more of your monthly payment to go toward the principal. Even a small difference can help, so it’s important to get multiple rate quotes when shopping for a mortgage. Having strong credit can also help you qualify for the best mortgage rates and therefore potentially afford a higher-priced house.

Down Payment

Your down payment is a lump sum of cash you give the lender at closing. It’s calculated as a percentage of your home’s purchase price, such as 10%, and you finance the remaining cost with the home loan. A larger down payment means you’ll borrow less and potentially qualify for a lower interest rate and avoid private mortgage insurance. All of these factors shrink your monthly mortgage payment and could allow you to buy a higher-priced home.

Income

Generally, a higher annual income allows you to afford a more expensive house (and vice versa). But the amount of house you can afford also depends on how much of your income goes toward other expenses.

Debt-to-income Ratio

Your debt-to-income (DTI) ratio tells lenders how much of your income goes toward paying debt each month. You can calculate your DTI by adding up your monthly debt payments (including your new estimated housing payment) and divide the number by your gross monthly income. If you spend $2,500 a month on various debts (including the estimated mortgage payment) and earn $7,000 a month, for example, then your DTI ratio is about 36% ($2,500 / $7,000 = 36%).

The major mortgage programs all set desirable DTI ratio limits. To qualify for a home loan, you may need a DTI ratio around 36% to 43%. Some loan programs allow you to go up to 50% with lender approval, but proceed with caution. Having too much debt can strain your budget.

Property Taxes and Insurance

Homeowners pay property taxes to cover local government services and homeowners insurance to protect against things like severe weather and theft. These expenses vary widely based on where you live, but the average American homeowner pays $140 a month toward taxes.

Mortgage Insurance

Mortgage insurance is a type of insurance that protects your lender if you stop making payments on the home loan. Mortgages insured by the Federal Housing Administration (FHA loans) and the U.S. Department of Agriculture (USDA loans) come with mortgage insurance, potentially for the life of the loan.

Conventional conforming loans may include PMI. If you put down less than 20%, you typically need to pay PMI.

Both types of mortgage insurance increase your monthly mortgage payment, which reduces the amount of home you can buy.

Homeowners Association (HOA) Dues

If your new home is part of a homeowners association, you’ll typically pay dues on a regular basis. The dues pay for the insurance, maintenance and upkeep of shared buildings and amenities. The average HOA fee across the U.S. is $191, according to the U.S. Census Bureau. But the amount you pay can vary greatly with each HOA.

How to Increase Your Home Buying Budget

If you want to afford a higher-priced home, here are a few steps you can take:

• Save for a large down payment. Making a larger down payment will lower the amount you need to borrow, which may help you afford more house. Tuck the money away in a place that’s separate from your spending money but where you can easily access it. A high-yield savings account can help the money grow as you save.
• Work on your credit. While it’s possible to buy a home with poor credit, improving your credit score may help you qualify for a lower mortgage rate—and potentially afford more house. Pull a free copy of your credit report from AnnualCreditReport.com and look for errors that can drag down your score. Then focus on other areas, like making on-time payments on all your bills and paying down your credit cards.
• Improve your debt-to-income ratio. You may decide to pay down some of your debts, which can help your DTI ratio and boost your credit score. Or you might be able to negotiate a pay raise at work. Both methods increase the income you have available for a mortgage payment.