How Much House Can I Afford?
Kevin Graham13-minute read
December 02, 2021
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When you're interested in buying a home, there are several questions that likely come to mind. What’s the necessary number of bedrooms and the appropriate size of the yard? Do you like an open concept?
Before asking any of the shopping questions though, there’s one key question to start with: How much house can I afford? We’ll go over how to answer that question and some related ones below. Let’s begin by going over a tool you can use as a jumping off point to get your head around some initial numbers.
Home Affordability Calculator
Our home affordability calculator is a simple way to play around with numbers and estimate home much home you can afford.
As you test out the home affordability calculator, learn more about its capabilities below.
Mortgage Affordability Calculator
If you’re a first-time home buyer, before really considering moving forward with a preapproval and getting an official budget, it helps to get an idea of the numbers involved. The Rocket Mortgage® Home Affordability Calculator helps home buyers get an idea of how much house they can afford along with the amount of money needed for a down payment and closing costs on homes in their price range.
There are really two different pieces of calculator functionality here. The first gives you a ballpark estimate of what you can afford. There are several key pieces of information:
- Where are you looking to buy? This allows us, where possible, to get a realistic figure for your property taxes and homeowners insurance costs.
- What’s your gross annual income? This is your income before taxes. Lenders consider the percentage of income that will go toward the mortgage when determining how much of a monthly payment you’ll qualify for.
- What available funds do you have right now? This determines how much money you have available for a down payment and closing costs.
- What are your monthly debt payments? This includes any existing installment payments on things like cars and student loans as well as minimum monthly credit card payments.
- How much do you pay for other expenses? Think of this as anything that’s not considered debt, but that you pay for every month. The biggest one is usually rent, but don’t forget about groceries and perhaps your entertainment budget if you have subscription services.
- What’s your estimated credit score? Your credit score is used in affordability estimates because it helps determine what loan options you qualify for. Based on this, lenders can calculate what your minimum down payment might be. In addition, your credit score is one of the key factors that determines your interest rate, the size of your down payment being the other.
In addition to being able to get an affordability estimate, there is separate functionality that lets you calculate how much cash you might need to buy the home you want. The calculator takes the following inputs:
- Where is the potential home? This allows for an estimate of third-party closing costs in your area. Think of things like title insurance and county recording fees.
- What’s the price of the home? This is used as the basis for any percentage calculations on your down payment.
- What’s your annual pretax income? Along with estimated minimum monthly debt, this helps determine what loan options you may qualify for, which directly impacts your minimum down payment.
- What’s the minimum payment on all your monthly debts? Just as you did when you estimated your home affordability above, you want to include your minimum monthly installment and revolving debt payments.
- What’s your best guess as to your credit score? As noted above, this lets us know what mortgage loan options you might qualify for, which is key in determining the minimum down payment required to buy a home.
How Much Mortgage Can I Afford?
When it comes to your mortgage, there are two key limiting factors that determine how much you can spend on a home. The first is how much you have saved for a down payment compared to the minimum required for the house you want to buy under the mortgage option you qualify for. The second factor is the amount of the monthly payment that you can afford.
In determining the monthly payment you qualify for, lenders look at a couple of different ratios. One is a housing expense ratio, which compares the amount of your monthly house payment including property taxes and homeowners insurance as well as (if applicable) mortgage insurance and homeowners association (HOA) dues.
The second ratio is called your debt-to-income ratio (DTI). Basically, your other debts are added to your mortgage payment and compared to your pretax monthly income. Both your housing expense ratio and DTI are expressed as percentages.
Although every loan option is different and many allow higher ratios, to comfortably afford your mortgage, a good general guide to follow is the 28/36 rule. If you use this as a measuring stick, you don’t want to spend more than 28% of your monthly income on your house payment. Further, your total monthly debt load should be no more than 36% of your monthly income.
Although the mortgage is the biggest cost many people think about, it’s also important to consider the additional costs of buying a house. In addition to the down payment and monthly payment, there are other closing costs for things like credit checks, origination fees, title and recording fees. Finally, after you close, you’ll need to consider monthly maintenance costs. Depending on the age of the home, we recommend budgeting 1% – 3% of the purchase price per year.
How To Determine What House You Can Afford
We already began to touch on some of this, but let’s dive deeper into the specific factors that determine what house you can afford on your budget.
This should be obvious, but the more income you make, the more you can afford. Duh, right? While this is certainly true, there’s just a little more that lenders are thinking about.
If you’re hourly or salaried, lenders are concerned with making sure that the income you receive is something that you get on a regular basis. Not only your base salary, but the commissions and bonuses you get have to be coming in fairly often in order to be counted on. If you’ve been 20 years at a company and you’ve gotten a holiday bonus every year, your lender can assume the income rather than a year’s subscription to the Jelly of the Month Club.
Seasonal income can also be assumed as long as you have a history of receiving it. For example, perhaps you work on a Christmas tree farm in late November and early December each year. The key is to always be able to show consistency.
Your current debt is compared to your income in order to figure out the monthly payment you can afford. For most types of debt, the process is straightforward. Monthly installment payments are added together along with minimum payments on credit card statements. This works for car loans and personal loans, for example. Student loans work a little bit differently.
Depending on the type of loan you get and your documentation, you either qualify with the monthly payment on your statement, the one showing up on your credit or an assumed percentage of the balance expected to be paid off every month. Talk to your lender about your situation.
Your DTI ratio is a major determinant of what you can afford. We’ve touched on it briefly in other sections, but here’s the actual formula:
Installment debt + Revolving debt
_________________________________________ × 100
Gross monthly income
This DTI formula is referred to as back-end DTI or overall DTI. When only your housing expense ratio is being considered, that’s called a front-end ratio. The formula for this is as follows:
Mortgage payment (including escrow for taxes and insurance + HOA dues)
_________________________________________________________________ × 100
Gross monthly income
For reference, the housing expense ratio is the 28 in the 28/36 rule. Back-end DTI is the 36 figure.
Not every loan product has a guideline for housing expense ratio. Some just go by the final DTI figure. Those that do include a housing expense ratio generally won’t approve you if it’s above 38%.
DTI can be dependent on the product you’re being approved for and even your credit score, among other factors. For example, you can be approved for an FHA or VA loan with a median FICO® Score of 580 or better at Rocket Mortgage®, but you’ll need to keep your DTI at 45% or lower and your housing expense ratio no higher than 38%. Above 620, your overall DTI can be as high as 57% for FHA and 60% for VA loans.
The amount that you have available for your down payment impacts how much you can afford. The first factor to consider is how the property is being used. The minimum down payment on primary properties is anywhere between 3% – 5% if you’re getting a one-unit property. Multiunit properties in which you live in one unit and rent out the others can have down payments of at least 20% for 4 units.
If it’s a vacation home, you’ll need to put at least 10% down. That one is the most straightforward.
Finally, if you’re looking to buy an investment property, you’ll need at least 15% down depending on the number of units. More units mean a higher down payment.
The other piece that has an impact is the size of your loan. If you want a jumbo loan beyond conforming loan limits, you’ll need at least 10.01% down, but the minimum increases to 25% if the loan amount is above $2 million. It can also be higher depending on the way the property is occupied.
In general, VA loans and USDA loans don’t have a down payment associated with them if you’re eligible. The exceptions to this are if it’s a jumbo VA loan above normal conforming loan limits or if you have impacted entitlement. Impacted entitlement involves having a previous VA loan that wasn’t fully paid off. You may have to make a down payment if your remaining entitlement doesn’t cover at least a quarter of the purchase price.
There are definite advantages to having a down payment that’s higher than the minimum. On a conventional loan, you can avoid mortgage insurance payments if you make a down payment of 20% or more. Even if your down payment is less than 20%, the amount you pay for mortgage insurance decreases the closer you get to that number.
For FHA loans, mortgage insurance is removable if you’ve made a 10% down payment after 11 years. Otherwise, it sticks around for the life of the loan. However, the amount of your down payment does impact how much you pay for mortgage insurance on an annual basis.
Beyond mortgage insurance considerations, the higher your down payment, the lower your rate will be if everything else is held equal. If you put down more money up front, the lender doesn’t have to give you as much and you’re a lower risk.
In addition to your down payment, there are other closing costs associated with getting a mortgage. On a typical purchase, these are 3% – 6% of the loan amount. They include things like an origination fee, lender’s title policy, funding an escrow account and recording fees, among many others.
There are also costs that are specific to certain loan types. Although VA loans don’t have a required down payment, they have a VA funding fee that must be paid with a few exceptions. Ranging from 1.4% – 3.6% depending on the size of your down payment and whether you’re a first-time or subsequent user of a VA loan, you can pay it up front or build that into the cost of the loan. FHA loans have a similar upfront fee of 1.75% of the loan amount for mortgage insurance in addition to the annual premiums. This can also be built into the loan.
One way to reduce or eliminate closing costs altogether is to take lender credits. These work in the opposite way that mortgage discount points do. One mortgage discount point is equal to 1% of the loan amount, but they can be purchased in increments down to 0.125%. These are interest points prepaid at closing in exchange for a lower rate.
Lender credits mean reduced or eliminated closing costs. The trade-off is a higher rate.
Your credit score is a big determinant for which mortgage options you qualify for. As such, your credit score is one of the biggest factors, along with property type, in what your minimum required down payment is going to be.
Beyond that, along with your down payment and the way the property will be occupied, your credit score is a huge factor in what your interest rate is. This is perhaps the biggest advantage in the mortgage space to having a higher credit score. Assuming the same level of down payment and similar occupancy, a person with a higher credit score will have a lower rate than a person whose score is lower.
How Different Loans Affect Home Affordability
Different types of mortgages have different terms that impact how much you can afford when buying a home. Here’s a breakdown of what you need to consider when looking at four different common loan types:
- Conventional loan: The minimum down payment on a one-unit primary property is 3% for first-time home buyers. The biggest loan-specific cost that comes with a conventional loan is the possibility of private mortgage insurance (PMI) if you make less than a 20% down payment. It’s anywhere between 0.5% – 1% of the loan amount annually depending on the size of your down payment. The good news is that you can request that it comes off once you reach 20% equity.
- FHA loan: In addition to a 3.5% minimum down payment, there’s an upfront mortgage insurance premium of 1.75% on FHA loans to go along with annual mortgage insurance premiums anywhere from 0.45% – 1.05% depending on the length of your loan term, the amount of your loan and your down payment. The annual mortgage insurance premium is split into monthly fees.
- VA loan: Although there’s no down payment associated with a VA loan, they do come with a VA funding fee in most instances. It’s 1.4% – 3.6% depending on how much you put down and whether it’s your first time using the VA loan.
- USDA loan: If you fall within the income limits and you’re in an eligible area, a USDA loan could give you the chance to get into a home with no down payment. There’s an upfront guarantee fee of 1% and an annual guarantee fee of 0.35% of the unpaid principal balance per year. This functions like mortgage insurance, but it’s lower than the fees associated with FHA loans. Rocket Mortgage doesn’t do USDA loans at this time.
Options If You Want More House Than You Can Afford
If you want or need a home that you can’t qualify for right now, there are several steps you can take to work to put yourself in a better position.
Lower Your DTI Ratio
There are two ways you can lower your DTI ratio: raise your gross monthly income or lower your existing debts. Either gives you more room to qualify for a higher loan amount in the eyes of lenders.
Making more money sounds like a tall order and we get it. You can’t just walk into the corner office and demand more money from your leader. The good news is there’s never been a better time to put other talents to use. The gig economy has never been stronger. Whether it’s driving for a ride-sharing service or contributing on a freelance community like Fiverr, there are many side hustles you can pick up to make extra money.
Beyond that, if you can set some extra money aside, you can lower your DTI by paying off existing debts. If you’re paying off debt for the purpose of lowering your DTI, you want to start by paying off the debts with the biggest monthly payment and move sequentially from there.
Improve Your Credit Score
Improving your credit score is another great way to improve your qualification prospects. Not only will you potentially qualify for more loan options, but a higher credit score means a lower rate from mortgage lenders.
Here’s a list of things you can do to improve your credit score:
- Pay off your debts. A positive effect of lowering your DTI ratio is that as you pay off debt, it should increase your credit score as well. From a credit score perspective, some things on your credit report are worse than others, so try to pay off collections and charge-offs first. Even if you can’t fully pay them off, see if you can work out a deal with your creditors. Although there will still be a credit hit, having something show up as “paid as agreed” is better than not dealing with it at all.
- Make payments on time: A big part of your credit score is simply about making on-time payments. If creditors know you pay regularly, you’re a better risk.
- Rebuild when you have to: It’s generally not a good idea to take out new credit just before buying a home. However, if you have a bankruptcy or foreclosure in your past and need to start over a ways out from buying a house, you can start with a secured credit card or credit building personal loan. The most important thing is to keep making the payments on time every month. You’ll build up your score and be able to work toward loans and credit accounts with more advantageous terms over time.
Cut Unnecessary Expenses
Whether you’re looking to save money for a house or to pay down debt and improve your DTI, taking a hard look at your budget and cutting unnecessary expenses where you can could be very helpful.
You don’t need to live on microwaved noodles, but knowing you’ve cut where you can and that you’ve done everything you’re comfortable with to meet your homeownership goal as soon as possible isn’t a bad feeling to have.
They don’t have to be major lifestyle changes, either. Maybe you cut back on the entertainment budget or take a staycation. Make a date night out of cooking together rather than eating out. Little things start to add up.
Consider Your Mortgage Options
Lastly, it might not be anything you're doing wrong. It's important to consider all your mortgage options. Different lenders have different loans available. The also set their own terms and pricing, so it's important to be aware that you won't always get the best deal by going to the first lender you see.
One other key thing to look at is the difference between the interest rate and the annual percentage rate (APR) associated with the loan. The bigger the difference, the more the lender is charging you in closing costs.
The Bottom Line
If you’re looking to determine how much home you can afford, a good mortgage calculator can help. However, you should also consider your own budget and what you can comfortably pay. A good guideline here is the 28/36 rule that you shouldn’t spend more than 28% of your monthly income and your house payment and no more than 36% of your income on all of your debts.
Beyond that, several factors determine what you can afford, including your DTI, the down payment and closing costs associated with your loan. Higher credit scores mean lower rates. Some of the fastest ways to improve your options include lowering your DTI and improving your credit score.
Doing the legwork needed to figure out your own housing budget will put you in a great position to get preapproved. You’ll likely have all of the information your potential lender will want, and the process should go quickly and smoothly. Getting preapproved will give you more confidence in your calculations and will likely make you more appealing to sellers.
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