How much house can I afford?
If you’re in the market to purchase a new home — congratulations! Buying property can be a great investment, and owning a home is an exciting milestone. As you enter the process, one of the first things you need to do is set and understand your budget. How much house can you afford? We put together this guide and our mortgage calculator below to help determine the amount of money you can comfortably spend on your monthly mortgage.
How to calculate mortgage payments
There isn’t one factor that determines how much house you can afford — you should consider a series of factors and formulas to help you determine what your budget should be. Your total mortgage payment will be made up of more than just the principal loan amount; you’ll need to factor in interest, taxes and insurance to get a clear picture of your future mortgage payment. Be sure to include other expenses, such as HOA dues, any planned home maintenance projects and other housing costs.
The 28% rule
The 28% rule is a widely accepted rule of thumb for determining your ideal mortgage payment. The rule is simple and states that your maximum household expenses should not exceed 28% of your monthly gross income.
Similarly, some financial experts recommend that a person’s total monthly debt payments, including mortgage, student loans, car payments, credit card debt and any other debts not exceed 36% of their gross monthly income. You may hear this commonly referred to as your debt-to-income ratio.
Lenders decide whether or not they can preapprove you for a loan by determining your debt-to-income ratio. Lenders consider what your new house payment will be, including necessary insurances and property taxes, when they formulate your debt-to-income ratio. Don’t forget to consider the following monthly debts when calculating your debt-to-income ratio:
- Credit cards (including store cards)
- Student loans
- Auto loans
- Bills that have gone into collections
- Child support
When determining how much house you can afford, you’ll want to understand your current debt-to-income ratio, all monthly obligations, your liquid assets, how large of a down payment you can afford and what your closing costs will be.
Use the ConsumerAffairs mortgage affordability calculator below to discover what house price you can realistically afford. Alternatively, you may consider lowering your projected monthly payment using the slider above to find a home price that would allow for more flexibility in your finances or let you make extra payments on your mortgage to pay the loan off faster.
Mortgage calculator methodology
Understanding how much house you can buy for a given monthly payment requires looking at multiple factors, including your loan term, mortgage interest rate, down payment and property taxes in your area. To determine whether a home price is affordable, we used the 28% rule and the following assumptions.
PMI: Private mortgage insurance, or PMI, is assessed by banks to help cover risks associated with home loans for buyers with smaller down payments. For the purposes of this calculator, we assume a 1% annual PMI fee for home purchases with less than 20% down. If you enter a down payment equal to or greater than 20%, we do not include PMI costs.
Homeowners insurance: According to the Federal Reserve Bureau, the average cost of an annual premium for homeowners insurance is $300 to $1,000. For most homeowners, the annual costs for a homeowners insurance policy can be estimated at 0.35% of the home price. Check with your insurance agent for a more personalized estimate.
How to find a mortgage lender
The next step in the homebuying process is to meet with a mortgage lender, either a broker or a bank, who will preapprove you for a loan. Homeowners often get their mortgage loan from a local bank, which can be a convenient way to keep track of all of your assets.
One benefit of working with a mortgage broker instead of a bank is that a mortgage broker might be able to set you up with a lender that works with borrowers who have higher debt-to-income ratios. When you work with a bank, you are at the mercy of its lending policy. A mortgage broker, on the other hand, has access to a variety of lenders and can help you find one that will work with you and your particular situation to get the best mortgage for your needs.
It's crucial to work with a lender that has experience with different types of loans, houses and homebuyers. You want to work with a company that has seen a lot of transactions and won't be thrown off if/when something unexpected happens during your homebuying process.
Seek local referrals from realtors — realtors tend to have experience working with lenders and can identify which ones would be a good fit for you. Asking friends who have recently gone through the process of getting a mortgage is another great way to find a reliable lender, as is reading mortgage lender reviews.
Getting an affordable mortgage payment
When you start to think about your budget, it's important to differentiate between how much house you can afford and what type of mortgage payment you can realistically pay back.
Being able to afford a large payment doesn’t mean you should go to the edge of your budget. If you can find a home that suits your family’s needs below your budget, all the better. It’s always a good idea to be conservative when determining your budget.
What to do when your monthly income is not steady
People who are self-employed, work on commission or get a fluctuating monthly bonus will have greater difficulty figuring out their maximum budget than those who earn a paycheck that’s a consistent amount. Anyone with these factors should work with a lender very early in the process to get a better idea of their average monthly budget.
Everyone thinking about buying a home should build their savings, but this is crucial for people with inconsistent monthly incomes. Begin saving as soon as you start thinking about buying a house so you have enough money to get the house and mortgage you want.
When it’s okay to go to the top of your budget
If you already have significant savings and you know your monthly income is going to remain stable and/or increase in the near future, then it might be safe to push to the high end of your mortgage budget if you feel comfortable doing so and you know you will have the cash on hand every month to make your full mortgage payment. This might makes sense for:
- People with stable employment and a very high probability of staying employed, such as government workers
- People who know they will have a big increase in income due to something like a spouse going back to work or an impending bonus/pay raise
- People who are about to get a significant amount of cash by selling off liquid investments
Some lenders will approve you for a mortgage that takes your debt-to-income ratio higher than 43% if they believe you will be able to make your payments in full and on time. Others will deny your loan because they do not feel confident you will be able to fulfill your loan obligations.
If a lender refuses to approve you for a loan, ask if you are "approve eligible," which means you are eligible for approval based on your application — just not from this particular lender. If the answer is yes, you know you might be able to get another lender to approve you.
How does a down payment work?
Your down payment is the amount of cash you pay toward your home upfront. This amount is not included in your mortgage since you have already paid it. The more money you put down, the lower your monthly payments will be. You can also typically get better interest rates with a higher down payment.
Ideally, you'll make a down payment of at least 20% of the total cost of your home to lower your monthly payments and avoid paying private mortgage insurance. However, it is possible to buy a home by putting less money down. An FHA loan, which is backed by the Federal Housing Association, only requires homeowners to put down 3.5%, and most mortgage lenders will go as low as 3% for a minimum down payment on a conventional loan.
What can you use for a down payment on a house?
Any required down payment must be made upfront and is not included in the loan, and you need to prove the money you are putting down is yours or was given to you as a gift. To that end, the money needs to be in your account for 60 days (or two statement cycles) before closing. Because of this deadline, you should cash out any liquid assets you plan on using toward your down payment at least 60 days before closing.
It is possible in some circumstances for funds that have not been "seasoned" (that is, that have not been sitting in your account for 60 days or longer) to count toward your down payment. You will need to be able to document the source of these funds. Talk to your lender if you have any assets you want to use toward your down payment to find out what steps you need to take to make sure they count at closing.
Here are some examples of assets that can be used for your down payment:
- Checking account
- Savings account
- Money market account
These assets cannot be used for your down payment since they are not liquid (meaning they cannot be used as cash):
- Life insurance
- Expensive/rare art
Note that credit cards are not a suitable form of cash asset to put toward a down payment. Even though you can take a cash advance on a credit card, they are considered borrowed funds.
What to do if you can't afford your mortgage payment
Even with careful thought, savings and a conservative budget, people sometimes find that they bought more house than they could afford. Losing a job or enduring a catastrophic injury or illness can cause homebuyers to lose enough income that they can't afford their monthly mortgage payment. Homeowners who are in over their heads should seek help from a credit counselor to find out all of their options.
Decide whether you want to stay in your home and work with a credit counselor to determine which of these options is in your best interest:
- Loan modification: Many lenders will work with homebuyers to modify the terms of their loan so they can keep their house and continue to make payments.
- Mortgage refinance: Depending on how long you have been in your home, you may be able to refinance your mortgage for a lower monthly payment.
- Work out a repayment plan with your lender: Some lenders will be willing to work with you on a repayment plan that lets you pay your missed mortgage payments over a period of time.
- Forbearance: In the case of extreme emergency (including a job loss or a catastrophic injury or illness), your lender may grant you forbearance on your mortgage. This means you can stop making payments for an agreed period.
- Short-sale: A short-sale is when you sell your home for less than it is worth. While this is certainly not an ideal scenario, you get out of your house without going through foreclosure or taking a hit on your credit score. Talk to your lender to see if you can work out an agreement in which you sell your house to pay off your mortgage.
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