Before you can start shopping for a house, you first need a good grasp on how much you can afford to spend. How do you figure that out? Well, it takes some careful calculations.
Are you eyeing homeownership? Use this guide to determine how much house is within your means.
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How Much House Can You Afford?
How much home your budget allows you to buy depends on several factors. Your household income and earnings play a big role, of course, as do your monthly expenses and debts beyond those for housing. With these numbers in mind, you can determine what sort of payment you can comfortably afford each month while still having enough left over for your other obligations.
That’s just the beginning, though. Other factors that influence your home purchase budget include the size of down payment you have assembled, along with your credit score and the cost of annual property taxes and homeowners insurance Then come the mortgage loan term, type and lender you choose. If you have other financial goals — like saving for college or retirement — these, too, will have to be factored into your home-purchase number.
If you simply want a general idea of what you can afford as a homebuyer, a home affordability calculator is a good place to start. To get the most accurate calculation, make sure you know your gross monthly income and minimum debt payments, your credit score, your projected down payment and the home loan program you expect to use.
A caveat about some calculators, though. Money’s calculator requires you to add further expenses, such as your monthly home insurance premium, property taxes and, if applicable, your homeowners association (HOA) dues and private mortgage insurance (PMI) premium. But not all such calculators require those to be added, and so only tell you what principal and interest payment you can afford. Considering only those mortgage expenses could result in an exaggerated sense of what you can actually afford, once these extra monthly expenses are considered as well.
How to Calculate How Much House You Can Afford
Every mortgage lender and loan program has its own criteria, so what you can borrow may vary by company. Typically, though, you can expect to afford more house if you have a good credit score, low debts and a large down payment. You can figure out how much you can afford by analyzing many aspects of your financial situation.
The 28/36 Rule
Many lenders use a guideline known as the 28/36 rule when determining how much you can borrow. It says that your projected housing payment — or the monthly principal and interest payment you’d pay on your new mortgage — shouldn’t take up more than 28% of your monthly earnings. So, for example, if you bring in $5,000 a month, most lenders would cap you at a maximum mortgage payment of $1,400.
Additionally, that mortgage payment plus any other minimum debt payments you have each month (car loans, credit card payments, student loans, etc.) should equal no more than 36% of your pre-tax income. In the above example, that would mean a maximum of $1,800 per month across all debts.
In the 28/36 rule above, those percentages are reflections of your debt-to-income ratio — or how much of your monthly income your debts account for. The 28% is the front-end DTI you should aim for, while the 36% is the back-end DTI — meaning the total monthly debt payments and your mortgage payment combined. To see what DTI you’re currently working with, use our debt-to-income ratio calculator.
There are loan programs that allow for higher back-end DTIs than 36%, so if you hope to borrow more than that would allow, these loans may be an option. With FHA loans, for example, you can actually have up to a 50% DTI in some cases. This could allow you to borrow significantly more than a traditional 36% DTI loan. (If you make $5,000 a month, it’d mean the difference between buying a home with a $1,800 monthly mortgage payment and a $2,500 one — or, at a 5.5% interest rate, a $317,000 home and a $440,000 one.)
The size of your down payment also factors into what you can afford. With a larger down payment, you have to borrow less money, meaning your mortgage payment is smaller and you can buy a more expensive home.
Let’s cite some examples of your options, assuming you can afford a $2,500 monthly mortgage payment, qualify for a 5.5% interest rate and want to put down a 20% down payment. In this scenario, your options might include:
- Make a $100,000 down payment and buy a $500,000 house,
- Make an $80,000 down payment and buy a $440,000 house, or
- Make a $40,000 down payment and buy a $200,000 house.
These are just examples, but generally speaking, the larger the down payment you can make, the bigger the purchase price you can consider. Just keep in mind: If you borrow more, it will mean more in long-term interest costs. You also may get a higher interest rate by making a smaller down payment.
Your credit score will also impact what you can afford as a homebuyer, largely because it influences the mortgage rate you receive. Typically, higher credit scores translate into lower mortgage interest rates (i.e., they’re more affordable), while lower credit scores mean higher, more expensive rates. For this reason, a low score generally reduces your borrowing power.
Let’s take a look at an example. Say you know you can afford a monthly payment of $2,500 per month. If you had a 780 credit score and qualified for a 5.5% interest rate, you could afford a home priced at $440,000. If your score was 600, though, and you only qualified for a 6.25% rate, your housing budget would drop to just $406,000 — nearly $35,000 less.
Ways to Improve Your House Affordability
Fortunately, there are many ways to increase the amount of home you can afford, so if you’re not happy with what current calculations are telling you, the strategies outlined below may help.
Lower Your DTI
Reducing your DTI ratio is one smart way to afford more home. To do this, you can increase your monthly or annual income (ask for a raise, take on a side gig or work more hours), or you can reduce your debts.
Debt reduction could involve any or all of paying down your credit card debt, making an extra car payment a year or paying off a debt entirely. All of these steps can reduce your debt load and so lower your DTI.
Raise Your Credit Score
If your credit score isn’t great, increasing it can help you get a better interest rate and, therefore, afford more home. To start, pull your credit report from each of the three credit bureaus, and see what you’re working with.
If you have late payments, get those settled and put your payments on autopay to prevent future slip-ups. Payment history accounts for 35% of your score, so on-time payments are critical to improving it.
You can also dispute any errors your find on your report, ask for a credit line increase or work on lowering your credit utilization ratio — which is, essentially, how much of your total available credit you’re actually using. All three of these steps can help increase your score.
Apply for a Federal Loan
Federal mortgage loans often allow higher DTIs than conventional loans, so using one of these programs might help you afford a more expensive home.
FHA loans allow up a DTI of up to 43% in most situations; in special circumstances — if you have a significant amount in savings, for example — that ration may even rise to 50%. A higher ratio can allow you to borrow more, even with other debts to your name.
A nice perk of FHA loans is that they have low down payment requirements and don’t require high credit scores. In some cases, you can actually qualify for an FHA mortgage with a credit score as low as 500 (although you’ll need a down payment of at least 10% to do it).
VA loans also allow for larger DTIs. Technically, the Department of Veterans Affairs wants borrowers to have a DTI of 41% or lower. Still, they make it clear that higher DTIs are allowed — especially if you have excess residual income (money left over after paying your housing expenses).
An important note here: VA loans are only for military members, veterans and their spouses. If you’re interested in using a VA loan, check out our guide to the best VA loans to get started.
A USDA loan is another option you might explore if a higher DTI is necessary. With these loans, you can have up to a 44% debt-to-income ratio as long as you have a credit score of 680 or higher. If your score is below this threshold, then you’ll need a 41% or lower DTI.
Again, these loans aren’t available to everyone. Only buyers purchasing a home in a designated rural area can use USDA mortgages. You can consult the USDA eligibility map to see if a home you’re considering qualifies.
Save Up for a Higher Down Payment
Making a larger down payment can also make a difference. As you saw in the earlier example, ponying up more in your down payment can allow you to purchase real estate that’s in a higher price range.
Just proceed cautiously if you go this route. It’s not a good idea to drain your savings in order to increase your down payment. First of all, you’ll need funds to cover your upfront closing costs. On top of this, it could put you in a bind if you lose your job or experience some other financial emergency. If you have time, work towards saving more money that you can direct towards increasing your down payment.
Shop Around for Your Lender
Because every mortgage lender has different fees and rates, comparing mortgage companies is also a great way to increase your buying power, too. This is particularly important in times of rising mortgage rates.
To start, zero in on a few lenders — your main bank, a credit union, an online lender and a big mortgage company. This gives you exposure to a wide range of lender types and pricing. Then, apply to get preapproved or pre-qualified with each.
Once you’ve finished, you’ll have a loan estimate from each of the lenders, which breaks down the costs and fees of the loan. You can then compare the estimates line by line to see which one is best for your budget and goals. When you’re ready to shop around, use our best mortgage lenders guide to get started.
Home Affordability Bottom Line
Whether you’re a first-time homebuyer or a homeowner looking for a new home, a lot goes into determining how expensive a house you can afford. While online mortgage calculators can help, they don’t always give you the full picture, so it’s important to know what affects your budget.
If you want the most accurate budget when buying your new home, speak to a mortgage professional or financial advisor before starting the homebuying process. They can help you understand what type of mortgage loans you’re eligible for, as well as what you can comfortably afford, given your financial situation.
Aly J. Yale is an experienced freelance writer and journalist, specializing in mortgage, real estate and housing. Her work has appeared in USA Today, Bankrate, Forbes, and Motley Fool, among other publications.