How much house can I afford?
Including your mortgage, your monthly debt payments should not exceed 45 percent of your total income. With that in mind, important factors to consider when setting your home budget include:
- Your current debt-to-income ratio
- Your expected income
- Your liquid assets
- Any work your new home will need that will add to your overall monthly costs
This guide and our mortgage calculator below will help you determine the amount of money you can comfortably spend on your monthly mortgage. If you are currently in over your head with your monthly mortgage payments, I have also included a list of things to consider before you turn to foreclosure.
Use the ConsumerAffairs mortgage calculator to find a realistically affordable home price, and learn the best ways to save for and buy a home.
Mortgage calculator methodology
When determining whether a home price is affordable or not, we use the commonly referenced “28 percent rule” which states that your home costs should not exceed 28 percent of your total income.
Understanding how much house you can buy for a given monthly payment is a function of a variety of factors including your mortgage term, interest rate, down payment, and property taxes in your area.
PMI: Private mortgage insurance, or PMI, is assessed by banks to help cover risks associated with mortgage loans for buyers with smaller down payments. For the purposes of this calculator, we assume a one percent annual PMI fee for home purchases with less than 20 percent down. If you enter a down payment equal to or greater than 20 percent, we will not include PMI costs.
Homeowners’ insurance: According to the Federal Reserve Bureau, the average cost of an annual premium for homeowners insurance is $300 - $1,000. For most homeowners, the annual costs for a homeowners insurance policy can be estimated at 0.35 percent of the home price. Check with your insurance agent for a more personalized estimate.
To help you figure out how to get the most house for your budget, I talked to mortgage and credit experts including Bruce McClary from the National Foundation for Credit Counseling and Richard Redmond, mortgage expert and author of Mortgages: The Insider’s Guide. I also read dozens of investment articles and books, including Mortgage Rip-Offs and Money Savers by Carolyn Warren.
How to calculate mortgage payments
There isn’t one single factor that determines how much money you can afford to pay for your home every month. There is, however, a formula that you can use as a starting point.
According to most lenders, your total monthly debt payments should make up no more than 40-45 percent of your monthly income. Lenders decide whether or not they can pre-approve you for a loan by determining your debt-to-income ratio. As far as your mortgage goes, our experts advise limiting your mortgage amount to no more than 28 percent of your income.
Warren explains that lenders consider what your new house payment will be, including necessary insurances and property taxes, when they formulate your debt-to-income ratio. The following items are also included:
- Credit cards (including store cards)
- Homeowner’s dues
- Student loans that will not be deferred within the next 12 months
- Auto loans
- Bills that have gone into collections
- Child support
You might already be thinking that tying up to 45 percent of your income in debt doesn't leave you a lot of breathing room for other things such as clothes, food, entertainment or savings for emergencies. You're absolutely right. This is why most mortgage advisors and experts recommend that homebuyers stick to a more conservative debt-to-income ratio.
How to make sure you have 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. “The problem,” Redmond says, “is that people want to push the edge of the envelope” when it comes to buying a house. He advises homebuyers, particularly first-time homebuyers, to be conservative when determining their budget. Homebuyers are typically so eager to purchase their dream home that they wind up with an impractical monthly mortgage. Redmond reminds them, “You can always buy up later.”
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 standardized paycheck. Redmond recommends that anyone with these “out of the box” factors work with a lender very early in the process in order to get a better idea of their average monthly budget.
Everyone thinking about buying a home should build up their saving, but this is crucial for people with inconsistent monthly incomes. Begin saving as soon as you start thinking about buying a house so that you have enough money at closing to get the house and mortgage you want.
When to go beyond your budget
While Redmond generally advises homebuyers to think conservatively when they begin looking for a house, he acknowledges some exceptions, including:
- People who are stably employed and have a very high probability of continuing to stay 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 signing bonus/pay raise
- People who are about to get a lot of cash by selling off their liquid investments
Basically, 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 for you to push to the high end of your mortgage budget, provided you feel comfortable doing so and you know you will have the cash on hand every month to make your full mortgage payment.
Some lenders will approve you for a mortgage that takes your debt-to-income ratio higher than 43 percent 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, Redmond suggests asking 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 to find a mortgage lender you can trust
The next step in the home buying process is to meet with a mortgage lender, either a broker or a bank, who will pre-approve you for a loan. Homeowners traditionally get their mortgages 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 according to Redmond is that a mortgage broker might be able to set you up with a lender that can do a higher debt-to-income ratio. When you work with a bank, you are at the mercy of their 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 important to work with a lender who has experience with different types of loans, houses and homebuyers. You want to work with someone who has seen a lot of transactions and who therefore won’t be thrown off if/when something unexpected happens during your home buying process. Redmond advises home buyers to seek local referrals from realtors since realtors tend to have experience working with lenders and can identify which ones would be a good fit. 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.
How does a down payment on a house 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, so the more money you put down, the lower your monthly payments will be. You can also get better interest rates with a higher down payment.
Ideally, you’ll make a down payment of at least 20 percent of the total cost of your home in order 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 percent, and most mortgage lenders will go as low as three percent for a minimum down payment on a conventional loan.
What can you use for a down payment on a house?
Your down payment must be made in cash, and you need to be able 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, sometimes people find that they bought more house than they could afford. Losing a job or enduring a catastrophic injury or illness can cause home buyers to lose enough income that they can’t afford their monthly mortgage payment. McClary advises homeowners who are in over their heads to seek help from a credit counselor to find out all of their options.
Decide whether or not you want to stay in your home, and then work with a credit counselor to determine which of these options is in your best interest:
- Loan modification: Many lenders will work with home buyers to modify the terms of their loan so that 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 allows you to 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 will be able to stop making payments for an agreed period of time.
- Short-sale: A short-sale means 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 and without 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.
Buying a home is a major decision. It is often an emotional decision, which is why it is so important to determine a budget before you start looking for a home. Staying within your budget is important for your financial well-being now and in the future. The consequences of falling behind on your mortgage payments are severe, so you want to budget conservatively to make sure you have enough money to take care of your other debt payments along with your everyday expenses. Make sure to read through customer reviews of mortgage lenders on ConsumerAffairs.com to find one that will work with you to get you into the house of your dreams without getting you into more debt than you can afford to pay.
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