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Reality Check: How Much House Can I Afford?

14-minute read

When you’re in the market for a new home, it may be tempting to try to buy the biggest or most expensive house that you can afford based on the number you find on your preapproval letter. However, the loan amount you qualify for doesn’t necessarily represent how much house you can afford. Just because a mortgage lender is willing to give you a certain amount of money, doesn’t mean that you’ll be able to pay it back in the end.

If you’ve found a home that you like and want to know if you can afford it, you may have already tried to use a mortgage calculator online. Mortgage calculators can provide you with a quick answer to whether you can afford that house, but you need to be careful when using these online tools. You may not be receiving the right answer – or worse, you may not even have the correct information to plug in.

Instead of taking a leap and suffering for it later, read through these tips to determine how much house you can afford on your budget.

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Factors That Determine Home Affordability

There are four main factors that determine home affordability. When trying to figure out how much house you can afford, you must consider your income, cash reserves, debt and expenses and credit profile. Here’s how each will impact the amount of money you can spend on a new home:

  • Income: The amount of money you earn through your salary, side jobs and investments will determine how much you can afford to spend on monthly mortgage payments. Calculating your total gross monthly income is the first step to figuring out the range of homes in your budget.
  • Cash reserves: The amount of money you have at your disposal based on savings, investments, gifts, etc. will determine how much you can afford to spend on a down payment and closing costs. The more funds you have available, the higher your down payment can be, which will enable you to either lower your monthly mortgage payments or purchase a home on the higher end of your budget.
  • Debt and expenses: Along with your income, your monthly debt payments and expenses will play a critical role in how much you can spend on a house. The more money that you have to spend to pay off student loans, credit cards, car payments, alimony, etc., the less money you’ll have to pay for a mortgage and housing-related expenses. But your groceries, utilities, telephone bills and other necessities must also be factored in to ensure that you have enough money available for day-to-day expenses.
  • Credit profile: When determining whether you qualify for a mortgage, lenders examine your credit score and debt profile. Individuals with higher credit scores and lower debts have an easier time qualifying for a mortgage and typically receive more funds from lenders.

How Do Lenders Determine How Much Mortgage I Qualify For?

Before you figure out how much house you can afford, it’s useful to know how lenders calculate whether you qualify for a mortgage. Mortgage lenders determine your qualification based on your credit score and debt-to-income ratio (DTI).

Your DTI enables lenders to evaluate your qualifications by weighing your income against your recurring debts. Based on this number, lenders will decide how much additional debt you’ll be able to manage when it comes to your mortgage.

To see if you’ll qualify for a mortgage, you can begin by calculating your DTI:

DTI = (Total Monthly Debt Payments / Gross Monthly Income) x 100

  1. Add all of the student loan, car loan, credit card, rent or house, child support, etc. payments you make each month to find your total monthly debt payments.
  2. Divide your total monthly debts by your gross monthly income. Your gross monthly income is the amount of money you make each month before taxes and deductions.
  3. Multiply the result by 100 to turn the decimal into a percentage.

 

Once you have calculated your DTI, you can evaluate whether it’s low enough to get approved for a mortgage. The lower your DTI, the more likely you’ll be to get approval.

If your total monthly debt is $650 (let’s say, $160 for your student loans + $370 for your car loans + $120 for your credit card debt), and your monthly income is $4,500 before taxes, your DTI would be 14%. A DTI of 14% is quite low, so you’d be likely to obtain a mortgage.

Very rarely will mortgage lenders give a loan to an individual whose DTI is above 50%. After calculating your DTI ratio, if you find that it’s over 50%, you’ll need to work on lowering it.

Apply Online with Rocket Mortgage®

Get approved with Rocket Mortgage® by Quicken Loans® – and do it all online. You can get a real, customizable mortgage solution based on your unique financial situation.

Tips For Improving DTI Ratio

The only ways to really improve your DTI are by increasing your income or paying down your debt. Let’s take a closer look at the ways you can increase your gross monthly income and lower your total monthly debt payments.

Ways To Increase Your Gross Monthly Income

Because your DTI is a ratio that calculates the percentage of your income that is spent on paying off debt, any extra money you make will automatically improve your DTI. So it’s helpful to begin lowering your DTI by increasing the amount of money you take home each month. Here are some ways that you can boost your take-home pay:

  1. Negotiate a raise: If you’re happy in your current role and are in good standing with your employer, it may be time to renegotiate your salary. Enhancing your productivity and taking on new responsibilities are great ways to prove to your employer that you’re deserving of a raise. Just make sure to rehearse what you’ll say to your boss ahead of time.
  2. Work overtime: If you feel that it’s unlikely you’ll be able to get a raise, you may want to consider requesting overtime or taking on more shifts. If you can get paid time and a half by putting more hours in, you may not need to have that tough conversation.
  3. Find a side hustle: If you have more time on your hands, earning extra cash through a side gig can make all the difference when trying to lower your DTI. When trying to find the best side hustle for you, think about your resources and skill set. For example, if you have an extra room, you can rent it through Airbnb. Or, if you have strong writing skills, you can find freelancing gigs.

 

Ways To Lower Your Total Monthly Debt Payments 

The key to reducing your debts is to create a budget and debt payment plan. By creating a list with your total monthly income on one side and all of your expenses on the other, you can quickly identify unnecessary expenditures, eliminate them and allocate extra funds to paying off your loans early. After coming up with your budget, you can use one of the following debt payment plans to chip away at your debts.

  1. Pay off debts with the highest monthly payments first: Since your DTI is calculated based on your monthly debt payments, paying off debts that have the greatest monthly costs first will enable you to reduce your DTI faster. This method can feel daunting, but it’s best for those who are looking to get approved for a mortgage sooner.
  2. Pay off debts with the highest interest payments first: If you have more time before you plan to apply for a mortgage, you may want to consider attacking payments that have the highest interest rates first. Although this approach may take longer to lower your DTI, it will save you more money in the long run.
  3. Snowball method: Using the snowball method isn’t the fastest way to lower your DTI, but it tends to leave those in debt with the greatest sense of accomplishment. After listing all your debt payments from smallest to largest, you can make minimum payments on all except your smallest debt. For your smallest debt, you put all extra money toward paying it off. Once you’ve eliminated it, you use the same strategy to make extra payments on your next smallest balance, chipping away until you’re left with only your largest debt. 

Although you can choose to focus on either increasing your monthly income or lowering your debts, it’s recommended that you do both simultaneously. Doing so will enable you to improve your DTI faster and ensure that you can qualify for a mortgage when it’s time to apply.

Avoid The Pitfalls When Determining How Much House You Can Afford

When determining how much home they can afford, people tend to use two basic strategies. Most base their assessment on how large of a loan lenders are willing to give them. But others use their current rent to determine how much they can afford to spend on monthly mortgage payments. The problem with these two approaches is that they tend to lead people to overestimate their budgets.

In order to know how much house you can afford, you not only need to think about how much you have saved but how much you’ll be spending. Although you’ll no longer be spending money on rent, you will have a slew of new payments that you need to consider, such as closing costs, property taxes, homeowners insurance and fees. And if the home you purchase needs work, you’ll also have to factor in the cost of home improvements.

‘How Much House Can I Afford’ Rule Of Thumb

When deciding how much house you can afford, the general rule of thumb is known as the 28/36% rule. This rule dictates that individuals should avoid spending beyond 28% of their gross monthly income on housing expenses and 36% on their total monthly debt payments.

So 28% represents the highest possible front-end ratio, which is the largest percentage of your income that should be allotted to mortgage payments. And 36% represents the highest possible back-end ratio, also referred to as the debt-to-income ratio, which you now know is the percentage of your income that is set aside to pay off debt.

Before calculating “how much house can I afford,” it’s necessary to have a firm grasp of what falls into the category of housing expenses. These costs are the various components of your monthly mortgage payment, which are often referred to as the PITIA:

  • Principal: This portion of the payment goes towards paying off the money that was borrowed to purchase the house.
  • Interest: This portion is the fee that the lender charges you for borrowing the money to purchase the house.
  • Taxes: This portion is the property taxes that you pay to the local government based on the value of your house. These real estate taxes are used to pay for local infrastructure, improvements, municipal salaries, etc.
  • Insurance: This portion is your homeowners insurance that covers your house in case any damage occurs. Lenders require you to pay this insurance to protect their (and your) investment from any potential unforeseen disasters.
  • Association dues: This portion is the fee that you pay if your house is part of a homeowners association. If your home is not a part of a homeowners association, you will not have to pay this fee. However, if you do, this money will go toward maintaining the community your home is in, as well as paying for any of the amenities that may be offered with your home. 

So to determine how much house you can afford, you should do the following calculations:

(Gross Monthly Income x 28) / 100 = Maximum Monthly Housing Expenses

(Gross Monthly Income x 36) / 100 = Maximum Total Monthly Debt Payments

So for a gross monthly income of $4,500, you shouldn’t spend more than $1,260 on housing expenses and $1,620 on debt payments each month.

Now, $1,620 may seem relatively high, but don’t forget, you still have to factor in the debt payments that you’re already making. So, $1,620 - $650 = $970. That means you’d only be able to afford a monthly mortgage payment of $970.

The chart below illustrates the maximum monthly mortgage payment you could afford based on different income levels.

 

 

Gross Monthly Income (Pre-Tax)

 

Maximum Monthly Housing Expenses Including PITIA
(28% Rule)

 

Maximum Monthly Debt Payments
(36% Rule)

Largest Monthly Mortgage Payment You Could Afford Based On $650 Of Existing Monthly Debt Payments

$2,500

$700

$900

$250

$3,500

$980

$1,260

$610

$4,500

$1,260

$1,620

$970

$5,500

$1,540

$1,980

$1,330

$6,500

$1,820

$2,340

$1,690

$7,500

$2,100

$2,700

$2,050

$8,500

$2,380

$3,060

$2,410

$9,500

$2,660

$3,420

$2,770

$10,500

$2,940

$3,780

$3,130

 

Home Affordability With Different Loan Types

As mentioned, the examples above are based on a conventional loan with a 20% down payment and an excellent credit score. However, in order to obtain a conventional loan, you must have the ability to make a substantial down payment – if less than 20%, you usually must pay for PMI – and a credit score of at least 620. Depending on your circumstances, you may find that a conventional loan isn’t right for you due to limited savings or mediocre credit.

If this is the case, you should consider a government-backed mortgage. Government-backed loans, such as FHA and VA loans, are good alternatives, as they provide borrowers with lower eligibility requirements and some relief when it comes to down payments. However, you must be eligible for these loans in order to reap the benefits.

FHA Loan 

Because FHA loans are guaranteed by the Federal Housing Administration, the requirements for qualifying for this type of mortgage are more lenient. If you’re purchasing a primary residence, have a minimum credit score of 580 and a DTI of 43% or less, you may be able to qualify for an FHA loan.

If you’re able to obtain an FHA loan, you’ll be able to make a down payment that’s as low as 3.5% of the purchasing price of the house. If your credit score is between 500 – 580, you may still qualify for an FHA loan, but you’ll have to make a down payment of 10%. 

VA Loan 

VA loans are mortgages insured by the U.S. Department of Veterans Affairs. These loans are made available to current and former members of the U.S. military, National Guard or military reserves. Spouses of veterans who died during active duty, are missing in action or are a POW may also qualify.

VA-backed loans enable qualified borrowers to purchase a property that they plan to live in without having to make a down payment or pay for PMI. Although the VA doesn’t require any specific credit score to qualify, lenders are able to set their own requirements. So when shopping around for a mortgage, you should find out what each lender’s eligibility requirements are for VA loans.

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How Does The Down Payment Affect How Much House I Can Afford?

It’s crucial to consider your down payment before determining how much house you can afford because the money you put down will drain a considerable amount of your savings. If you use up your savings on a down payment and have earmarked too much of your income for paying off your mortgage and other debts, you’ll find yourself in serious financial trouble should any emergencies or unforeseen expenses occur.

The higher the down payment you can make, the more equity you will have in your home after you purchase it. Let’s take a look at how the size of your down payment would impact your home equity if you were purchasing a home for $450,000.

 

Down Payment (As A Percentage Of The Purchasing Price)

Amount Of Money Spent On Down Payment

Amount Of Home Equity After Purchasing Property

20%

$90,000

$90,000

15%

$67,500

$67,500

10%

$45,000

$45,000

5%

$22,500

$22,500

3.5%

$15,750

$15,750

0%

$0

$0

 

Although down payments can be lower than 20% of the purchasing price, you should really try to stay as close to that number as possible, especially if you’re in the market for a conventional loan. You don’t want to get stuck paying PMI fees. But more importantly, you need to remember that the less you put down now, the more you’ll have to spend each month on your mortgage payments and the less equity you’ll have in your home.

Mortgage Affordability Calculators

As you continue to ponder “how much house can I afford,” you may realize that it’s a struggle to keep in mind all the factors that go into determining the answer. To help you figure out how much house you can afford, we’ve created a Home Affordability Calculator.

After you plug in your annual income, monthly debt, savings, ZIP code and credit score into the calculator, it will quickly compute the maximum home price you can afford. Plus, it will also list an appropriate mortgage option that will enable you to finance your home.

Once you know how much house you can afford, you can then use the Mortgage Calculator to see how your down payment will impact your monthly mortgage payments. Playing around with this calculator will enable you to see how putting down specific dollar amounts or percentages of the purchase price can make your monthly payments more or less affordable.

And unlike other versions, this mortgage calculator presents not only the costs associated with your principal and interest but also your property taxes and homeowners insurance. So you can get a full picture of what your monthly payments ultimately will include.

Words To Remember When Determining How Much House You Can Afford

Although you may be inclined to buy a house priced in line with the maximum loan amount a lender is willing to give you, remember that’s not the wisest decision.

When Dennis Spensley, Triple Crown Mortgage Banker at Quicken Loans®, works with clients, he makes sure that they have a precise understanding of what they’re getting into. “I explain the debt ratios that we work off of, but I also let them know that what we’re comfortable with and what they’re comfortable with may be two different things,” he says.

“They will be writing the check every month to us, and if they are not comfortable with the payment, I tell them that they should either lower their max purchase price or if they cannot find something in a lower price range, they should continue to rent,” Spensley adds. “I let them know that ethically, I do not want to be responsible for putting them into a bad loan.”

Just because a mortgage lender offers you a certain amount of money, doesn’t mean you should take it. Instead of maxing out your budget and buying a house that may cause you financial distress in the future, you should choose a home that meets all your needs but costs the least amount. Read our other resources on the home buying process and what makes the most sense for your needs.

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