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 advisers 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 at all-time lows right now, which has made homeownership more attainable for many buyers. Here are some of the factors that can affect your loan terms, which in turn will affect what you’ll be able to buy.
Lenders tend to give the lowest rates to people 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 per agency per year 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 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.
If you don’t have much saved up for a downpayment but feel ready to buy you can always refinance into a lower rate loan later, provided market conditions are favorable. If you decide to go this route, get your finances and credit score in tip-top shape now so you have a better shot at refinancing sooner. The faster you can lock in a lower rate, the faster you’ll be able to trim down your monthly mortgage payments.
Of course, 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 no or low down payments. Be sure to check with your local government or talk to your lender about programs you are eligible for. You can also visit our page about some of these programs, which include helpful contact information.
Many homebuyers think they need to put down 20 percent of the purchase price or more, and while it’s true that a bigger down payment can make you a more attractive buyer and borrower, you may be able to get into a new home with a lot less cash on hand.
Some programs make mortgages available with as little as 3.5 percent down, and some VA loans are even available with no money down at all. You may have to pay private mortgage insurance (PMI) if you put less than 20 percent down, but that extra charge will go away once you’ve built up sufficient equity in your new property.
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.