Start with budgeting basics
It’s a matter of looking at how much money you earn versus how much you spend. Don’t include what you’re currently paying in rent or mortgage in your expenses, since you will put that money toward your proposed mortgage.
Subtract your expenses from your income. The difference is what you have to work with when it comes time to buying a house. Once you have this figure in mind, you will get an idea of how much house you can comfortably afford.
What factors determine "how much house I can afford?"
Your housing costs with a mortgage will be affected, for example, by your credit score and the size of your down payment. Include taxes, homeowners’ association fees, private mortgage insurance (PMI), if your down payment is less than 20 percent, and any other anticipated fees in the total cost. This will give you a clearer picture of how much you’ll be spending each month.
Two houses with the same price tag in the same city can carry different monthly costs due to these variables.
How much house can you afford?
Use the 28-36 rule
Most mortgage lenders use the 28-36 rule to determine what you can afford and how much money they’re willing to lend you. The 28-36 rule states that your maximum household expenses shouldn’t exceed 28 percent of your gross monthly income. This is also called the housing ratio or the front-end ratio.
Likewise, total debt, which includes everything from student loans to credit cards, should fall below 36 percent of your income. This number is your debt-to-income ratio, or DTI. To get this number simply add all of your monthly debt and divide it by your gross monthly income. If your monthly income is $4,167, or $50,000 annually, and your debt is $600 per month then you have a DTI of 14 percent.
For those who are preparing to buy a house, following this rule will not only help you budget wisely but might also help you qualify for a loan since these ratios are important to lenders.
Affordability according to banks
The 28-36 rule is a general guideline lenders consider, but it’s not set in stone. In fact, per Fannie Mae rules, most standard loans have a 50 percent maximum allowable DTI ratio.
For manually underwritten loans, the maximum DTI is 36 percent. There are instances when lenders may bump that up to 45 percent if the borrower meets certain requirements.
The down-payment crunch
A major hurdle to homeownership is the down payment. Although many folks can afford to make the monthly mortgage payments, they don’t have enough cash for a conventional loan down payment, which can be up to 20 percent of the total cost.
Today, there area banks and government programs, such as FHA loans, that cater to otherwise qualified borrowers who don’t have a large down payment. Here are a few examples:
- Bank of America’s Affordable Home Solution
- CitiMortgage’s HomeRun loan program
- Navy Federal Credit Union ( it offers 3 types of 0 percent down programs)
- HomeReady mortgage created by Fannie Mae
- FHA, VA and USDA loans
The bigger affordability picture
Keep in mind that just because a lender will give you a mortgage of X amount on a home, that doesn’t mean you should go for the maximum. Think ahead about your circumstances. Are you qualifying based on two incomes when later you may only have one? What about the cost of raising children or financing retirement? Do you have an emergency fund to keep the mortgage going in the event of a job loss, and what happens if the house needs major repairs?
So the question isn’t how much house you can afford, it’s how much house you can afford and be able to pay for all the other things in life. Being house-rich and cash-poor can be an uncomfortable lifestyle.
Home Buyer Resources:
Use this calculator to figure out how much money you can borrow.
Thinking of buying a home? Consider these factors before making your decision.
Avoid these common mistakes when buying your first home.