How much mortgage can I afford?
You don’t want to wind up with a mortgage you can’t pay, so it’s important to be realistic about your monthly income and expected expenses, and to leave some breathing room in your budget for emergencies or unexpected costs that can crop up.
Why it’s smart to follow the 28/36% rule
Most financial advisors agree that people should spend no more than 28 percent of their gross monthly income on housing expenses and no more than 36 percent on total debt — that includes housing as well as things like student loans, car expenses and credit card payments. The 28/36 percent rule is the tried-and-true home affordability rule that establishes a baseline for what you can afford to pay every month.
Example: To calculate how much 28 percent of your income is, simply multiply your monthly income by 28. If your monthly income is $6,000, for example, your equation should look like this: 6,000 x 28 = 168,000. Now, divide that total by 100. 168,000 ÷ 100 = 1,680.
Depending on where you live and how much you earn, your annual income could be more than enough to cover a mortgage or it could fall short. Knowing what you can afford can help you take financially sound next steps. The last thing you want to do is jump into a 30-year home loan that’s too expensive for your budget, even if you can find a lender willing to underwrite the mortgage.
How to determine how much house you can afford
Your housing budget will be determined partly by the terms of your mortgage, so in addition to doing an accurate calculation of your existing expenses, it’s important to get an accurate picture of your loan terms and shop around to different lenders to find the best offer.
Mortgage interest rates are near all-time lows right now, which has made borrowing easier for many buyers. Unfortunately those low rates, coupled with limited available listings, have pushed prices up to record highs. But, if your budget works out, it can still be a great time to buy. Here are some of the factors that can affect your loan terms, which in turn will affect how much you can borrow.
Lenders tend to give the lowest rates to borrowers with the highest credit scores, lowest debt and substantial down payments.
It’s a good idea to get your credit in order before you apply for a mortgage. First, check your credit report at one of the big three agencies: Equifax, Experian, and TransUnion. You can get one free copy of your report per agency each week (through April 20, 2022) at AnnualCreditReport.com. Carefully review your report and note any incorrect information and negative factors.
If you find mistakes on your report, be sure to alert the credit reporting agency right away. Be aware, you might have to prove that the claims are wrong by providing payment history or other evidence. If it’s a case of identity fraud, then you will have to file a report with your local police department.
Your a class="text-link --bare" href="https://www.bankrate.com/mortgages/why-debt-to-income-matters-in-mortgages/">debt-to-income ratio, or DTI, compares your monthly income to your monthly debt. People with high debt relative to their income will have a higher DTI, and vice versa. This is an important number because it shows borrowers your bandwidth to assume more debt. The higher your DTI, the harder it will be to get a mortgage — much less a good interest rate. Many lenders won’t consider a borrower with a DTI above 43 percent.
For borrowers, it’s a good idea to pay off as much existing debt as possible to qualify for a mortgage as well as to make room for a mortgage payment. By paying off debt, you’ll be in a better position to manage your monthly costs and open up resources in case you run into emergency expenses.
Monthly expenses are not counted in your DTI, only debt obligations. So you don’t have to include things like utilities, gym memberships or health insurance.
Here's how to figure out your DTI:
Add up your total monthly debt and divide it by your gross monthly income, which is how much you brought home before taxes and deductions.
Add up your monthly debt: $1200 (rent) + $200 (car loan) + $150 (student loan) + $85 (credit card payments) = TOTAL: $1,635.
Now, divide your debt ($1,635) by your gross monthly income ($4,000). 1,635 ÷ 4,000 = .40875. By rounding up, your DTI is 41 percent.
If you get rid of the $85 monthly credit card payment, for example, your DTI drops to 39 percent.
Bigger down payments can mean better mortgage rates because lenders taking on less risk by giving you less money and making sure you have more equity in the home. The loan-to-value ratio, or LTV, takes into account your down payment. The bigger the down payment, the lower the LTV and the less risk the lender will assume.
What other factors determine how much house I can afford?
Beyond the price you offer to pay and the amount you have for a down payment, there are other expenses involved in home-buying, as well, including:
- Closing costs, which can include recording fees or transfer taxes in your location as well as fees charged by your lender and lawyer
- Property taxes, which often have to be set aside in escrow and are added to your monthly mortgage payments
- Homeowners insurance, which also can be paid through escrow
First-time homebuyer, low income and low down payment programs
It’s not always easy or practical to save up a large down payment. There are many first-time homebuyer, government and needs-based down payment assistance programs available for buyers with a low or no down payment. Check with your local government or talk to your lender about programs you might be eligible for. You can also visit our page detailing some of these programs, which includes helpful contact information.
Many homebuyers think they need to put down 20 percent of the purchase price or more. While it’s true that a bigger down payment can make you a more attractive buyer and borrower, you might be able to get into a new home with a lot less cash on hand. Some programs make mortgages available with as little as 3 percent or 3.5 percent down, and some VA loans are even available with no money down at all. You might have to pay for mortgage insurance if you put less than 20 percent down, but if you’re obtaining a conventional loan, that extra charge will go away once you’ve built up sufficient equity in your new home.
How much house can I afford with an FHA loan?
Federal Housing Agency mortgages are available to homebuyers with credit scores of 500 or more, and can help you get into a home with less money down. If your credit score is below 580, you’ll need to put down 10 percent of the purchase price. If your score is 580 or higher, you can put down as little as 3.5 percent.
You’ll still need to crunch all the other numbers, but these lower downpayment thresholds should be a shot in the arm for your budget.
How much house can I afford with a VA loan?
Eligible active duty or retired service members or their spouses can qualify for down payment-free mortgages from the VA. These loans have competitive mortgage rates but usually and don’t require PMI, even if you put less than 20 percent down. These loans be a great option if you qualify and can help you get into a new home without overstretching your budget.
Tips for buying an affordable home
- Set aside funds for home maintenance and emergencies. Unexpected expenses are par for the course for homeowners, so you’ll want to make sure you can cover them without taking on debt. Whether it’s a broken appliance or a pipe that springs a leak, home repairs always seem to happen at inconvenient times and wind up costing more than you’d expect. State Farm recommends setting aside 1 percent to 4 percent of your home’s value for emergency repairs each year.
- Plan for income changes. If you or your partner or co-borrower wants to switch up the employment situation after moving, you’ll want to make sure to factor that into your budget. You don’t want to wind up taking out a mortgage that you can no longer afford.
- Shop around to save on homeowners insurance. Comparing mortgage offers isn’t the only way to save. You’ll also want to solicit quotes from multiple insurers to make sure you’re getting the best deal.
- Stay within your means. A lender might be willing to offer you a larger mortgage than you’re comfortable with or able to pay. Don’t buy a house just because the bank tells you you can afford it — only commit to monthly payments that actually fit into your overall budget.