Buying a house brings along a wide range of emotions, from nervous excitement to sheer dread over the financial commitment. You might be tempted to make a full-price offer on the first house you see. However, it’s not necessarily the best decision you can make.
Just as the type of home you purchase affects the way you live your life, so too does the amount of money you spend. Your mortgage payment is probably your largest monthly expense, and if it’s too high, you might struggle to meet other financial obligations.
Or you might be ok paying for the necessities but may not have the wiggle room for fun purchases you typically enjoy. Before you start binging on Zillow searches, take a few moments to thoughtfully consider how much house you can afford.
Evaluate Your Existing Budget
When it comes time to apply for a mortgage, you must remember to advocate for yourself.
Loan officers use strict underwriting guidelines to approve loan amounts. However, even with those in place, you don’t necessarily want to borrow the full amount you’re eligible for.
Be sure to ask questions even after you’ve gotten an initial amount pre-approved. Where are interest rates for your credit category right now? What other types of fees and charges can you expect to pay?
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Property Taxes & Homeowners Insurance
Don’t forget about annual property taxes and homeowners insurance — those expenses are included in your monthly mortgage amount as well.
Your mortgage lender should break down all these associated costs so that you can see how the actual payments look at a certain price point. Then, you can experiment with a home affordability calculator or mortgage calculator. By doing this, you can find some numbers that feel comfortable to you.
Household Income & Current Level of Debt
So, what is comfortable when buying a house? It really depends on two things: your household income and your current level of debt. Most lenders allow for a total debt-to-income ratio of 43%. That means only 43% of your monthly pre-tax income may be used for monthly debt payments. This includes credit card debt, student loan payments, car loans, and your new mortgage payment.
If you have a lot of other types of debt, you might not be able to afford a large home. But even if you don’t have much debt, it’s still not prudent to spend 43% of your gross monthly income on your mortgage.
After all, you don’t want to max out your ability to borrow money in case you need another type of loan in the future. Some conservative estimates recommend budgeting no more than 25% of your after-tax income for your monthly mortgage payment.
See also: The Ultimate Guide for First Time Home Buyers
Determine Your Upfront Expenses
Getting a loan without much cash for a down payment isn’t difficult. However, you almost always need some funds up front. FHA loans allow for as little as a 3.5% down payment. That means if you buy a $200,000 house, you’d need a down payment of $7,000. USDA and VA loans typically come with 0% down payments so you don’t need any extra cash for this purpose.
However, the downside is that, except for VA loans, any mortgage with a down payment of less than 20% is subject to mortgage insurance. This is an annual expense you’re charged that protects the lender against default since you don’t have much equity in the home.
The annual interest rate depends on your loan type and is divided up among your monthly payments each year. It can easily add $100 or more to your mortgage payment.
Mortgage Insurance Fee
In addition to the monthly charge, most loan programs charge a one-time mortgage insurance fee on top of your other closing costs. For FHA loans, you’ll be charged 1.75% of your loan amount.
If you have a mortgage of $193,000 (assuming you put down 3.5%) your private mortgage insurance (PMI) premium at closing would cost $3,377.50. That’s on top of your other closing costs, like fees for the home appraisal, attorneys, escrow, homeowners insurance, and others.
Most buyers pay between 2% and 5% of their new home’s purchase price. That could be as much as $10,000 for a $200,000 home. You can try to negotiate closing costs as part of the seller’s concessions, but this isn’t always possible, especially in competitive real estate markets. You may be able to finance them as part of your mortgage, but that again increases your monthly mortgage payments.
Think About the Future
The amount you spend on a house should not only take into account your current finances, but also your future needs. You might be in a steady job now, but if there’s anything 2008 taught us, it’s that nothing is ever certain. Do a quick mental audit and determine how prepared you are for an unexpected job loss.
Do you have enough in your savings to pay your mortgage and other necessary expenses? Most financial experts recommend having at least three to six months of income set aside to prepare yourself for this type of situation.
Whether you lose a job, become ill, or become the caretaker of a relative, you need a plan that protects your home from foreclosure in an emergency.
Retirement Savings
Another consideration is your retirement, even if it’s decades away. You may be betting that you can sell your home and downsize when you’re ready. However, there’s no way to predict real estate trends. The best way to a successful retirement is by limiting your necessary expenses so that you can afford to live on a smaller annual income.
If you’re confident in your current retirement savings, then you might be able to afford your mortgage when the time comes. Or maybe you’re young enough where you expect to have that 30-year mortgage paid off before you’re ready to retire.
But life throws so many curveballs, it’s impossible to really know what your finances will be like in your 60s. Of course, you don’t want to live your entire life in fear, but always have multiple game plans in mind, rather than relying on one “sure thing.”
How to Afford a More Expensive Home
After researching and performing your due diligence, you might still find yourself ready to buy a higher-priced home. Maybe you need the space for your growing family, or perhaps you live in a city with a high cost of living.
After all, in many places, the cost of monthly rent is just as expensive—or even more so—than an actual mortgage payment. There are several ways you can bring down that monthly payment.
3 Ways to Qualify for a Better Interest Rate
Start by trying to qualify for a better interest rate. You can do this by raising your credit scores, reducing your debt, or increasing your earnings.
It’s no secret that your credit history greatly affects your ability to borrow. Both your debt and wages also impact the ever-important debt-to-income ratio. Most of these steps can’t be checked off on a weekend but can put you on a better path to financial stability.
Save More Money
You also have the option to save more money. Having extra cash on hand allows you to make a higher down payment. That, in turn, lowers the amount of the loan, reduces your monthly payment, and also gives you more equity in the home. If you can afford a down payment of a full 20%, you get the added bonus of saving on mortgage insurance.
With even more cash, you can pay all of your closing costs upfront. That way you don’t have to worry about adding that amount (plus the corresponding interest) to your monthly payment. It’s easier said than done, but you might be able to get your dream home with a temporary part-time job.
Refinancing Your Mortgage Down the Road
The good news is that once you have a mortgage, your loan terms don’t have to stay the same forever. You can refinance, which entails paying off your mortgage with a new loan with different terms.
Refinances have been popular recently because of historically low interest rates. However, the Federal Reserve has recently started implementing rate hikes, which are expected to continue gradually. While you shouldn’t count on lower interest rates for a future refinance, this process can help you in other ways.
Cash-out Refinancing & HELOCs
If you have equity in your home (typically 20% or more), you can do a cash-out refinance or a home equity line of credit (HELOC). Both allow you to access cash based on your home appraising for a certain value. You then either have a higher mortgage with the refinance, or repay the HELOC like you would a credit card.
The downside to a mortgage refinance is that it comes with all the costs associated with a new home loan. For example, you’ll have to pay for the appraisal of your home, usually amounting to a few hundred dollars. There will also be closing costs involved, which can either be paid for upfront or rolled into the new mortgage.
Because of these new expenses, you’ll need to do some math to figure out if the new loan makes financial sense for you. This, of course, depends on your goals, whether it’s lowering your monthly payment, getting out of your mortgage insurance, or cashing out on your equity.
A mortgage loan officer can help you with these calculations, but it’s also smart to crunch the numbers on different situations on your own. After all, you have no better advocate than yourself!
FAQs
How much of a mortgage payment can I afford?
When determining how much you can afford for a mortgage payment, there are a few key factors to consider. These factors include your household income, existing monthly debts (such as auto loans and student loans), and how much you have saved for a down payment. Knowing what your monthly mortgage payment will be is important for having financial security.
Though your income and current debts may remain consistent, there may be unexpected expenses or random spending that can take a toll on your savings. It is recommended to have three months of payments, including your housing payment and other debts, in reserve in case of an unforeseen event. This will help you cover your mortgage payment.
How much house can I afford with an FHA loan?
FHA loans are backed by the Federal Housing Administration and may have more relaxed qualifying standards than conventional loans. With a down payment of at least 3.5%, you may be able to get an FHA loan.
If you have a lower credit score, this could be a suitable option for you. To find out more, you can use an FHA mortgage calculator. For a conventional loan, you can have a down payment as low as 3%, but you may have to meet more stringent qualifications.
How much house can I afford with a VA loan?
You may be able to qualify for a loan of up to four times your annual income, depending on your credit and other factors. Additionally, VA loan limits vary by county, so you may be able to qualify for a higher loan amount in some counties than in others. To find out more about VA loan limits in your area, talk to a VA-approved lender.
How much house can I afford with a USDA loan?
The maximum debt-to-income ratio for VA loans is 41%, but borrowers with higher ratios may still be eligible as long as they meet other requirements. VA loans don’t require a specific credit score, and borrowers don’t have to make a down payment.
How much house can I afford on my salary?
How much house you can afford also depends on your current debt, savings, and other financial obligations. Generally, it is recommended that your total housing payments should not exceed 28% of your gross monthly income.
Your total debt payments should not exceed 36% of your gross monthly income. You should also factor in the costs of maintenance, insurance, and taxes when determining how much house you can afford on your salary.
This is also known as ‘The 28/36 Rule.’
What is the 28/36 rule?
The 28/36 rule is a widely accepted guideline for calculating a homebuyer’s affordability. It states that you should not spend more than 28% of your gross, or pre-tax, monthly income on home-related costs. Furthermore, they should not spend more than 36% on total monthly debt, including mortgage, credit cards and other loans, such as auto and student loans.
How much house can I afford on a $50K salary?
You may be able to purchase a home between $175,000 and $250,000 with a salary of $50K per year. The exact amount you can afford, however, will depend on your credit score, debt-to-income ratio, and the size of your down payment.
How much house can I afford on a $70K salary?
On a $70,000 annual salary, you may be able to purchase a home between $245,000 and $350,000, depending on your debt load, where you live, and the type of loan you choose. The exact amount you can afford will depend on the cost of living in your area.
How much house can I afford on a $100K salary?
On a $100,000 salary, you may be able to afford a home in the $350,000 to $500,000 range or higher. However, a good income is not enough to purchase a house. You’ll need a good credit score, minimal debt, and a decent down payment to be successful.
Bottom Line
Buying a home is expensive, no matter how you end up financing it. But it’s also an extremely personal situation that greatly influences how you live your life every day. The best way to figure out how much house you can afford is to find a balance between your heart and your head.
Obviously, you don’t want to be house-poor because of a mortgage, but you also want to feel safe, secure, and happy in your home. It’s an investment in yourself as much as it is an investment in real estate.
If you’re feeling overwhelmed with property listings, mortgage calculators, and loan applications, don’t be afraid to take a breather. Talk to a friend or family member who has bought a home in the past and ask for tips from their experiences.
They don’t have to dive into personal numbers, but they can give you an idea of things to be aware of throughout your own home buying process. When you’re ready, you can jump back into the process and get ready to afford the home of your dreams.
