How Much House Can I Afford? How To Assess Your Finances And Calculate What To Spend
Miranda Crace10-minute read
January 12, 2023
How much mortgage you can qualify for depends on how much debt a lender thinks you can take on. This will ultimately determine how much house you’re able to afford.
Read on to calculate how much house you can afford and learn what this means as you decide if you should buy a house and then start the search for your dream home.
Understanding How Much Mortgage You Can Afford
Buying a house is a huge undertaking, and it’s easy to get wrapped up in the excitement of it all. It’s crucial to be realistic about what you can afford, especially as the intensity of buyer demand in today’s housing market drives asking prices higher.
You want to hunt for homes that are in your price range so you don’t fall in love with a house that’s simply out of reach. Knowing your budget and sticking to it will make the entire home buying process run smoothly.
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Home Affordability Calculator
The Rocket Mortgage® Home Affordability Calculator gives you the option to see how much house you can afford, or how much cash you need for your down payment and closing costs.
If you’re looking into how much home you can afford, just enter your location, yearly income, monthly debts and how much money you have for a down payment and closing costs. The calculator will take this information and tell you how big of a loan you can take.
On the flip side, if you have a price in mind, you can use the calculator to see how much cash you’ll need for a down payment and closing costs.
The 29/41 Rule And How It Relates To Calculating Home Affordability
When lenders evaluate your mortgage application, they calculate your debt-to-income ratio. This is your monthly debt payments divided by your monthly gross income. Lenders look at this number to see how much additional debt you can take on.
According to the 29/41 rule of thumb, it’s best to keep your DTI within a range that’s defined by these two numbers. Here’s an example.
The first number, 29, represents your housing expense ratio. This is calculated by dividing your mortgage payment (principal, interest, real estate taxes, homeowners insurance and, if applicable, homeowners association dues and mortgage insurance) into your gross monthly income and converting it to a percentage.
It’s defined by the following formula:
Principal + Interest + Property Taxes + Insurance (Homeowners & Mortgage)
+ Homeowners Association Dues
_____________________________________________________________________________ × 100
Gross Monthly Income
The 41 represents your total DTI after all your other debts are added, including revolving debt (credit cards and other lines of credit) and installment debt – mortgage, car payment, student loans, etc.
That equation is as follows:
Installment Debt + Revolving Debt Payments
_________________________________________________ × 100
Gross Monthly Income
The 29/41 rule is important to know when thinking about your mortgage qualification because DTI helps lenders determine your ability to pay your mortgage. Although higher housing expense and DTI ratios are allowed under many loan types (including conventional, FHA, USDA and VA loans), the 29/41 rule provides a good starting point. You need to calculate how much house you can afford while maintaining a wide range of loan options.
Make sure your mortgage payment (principal, interest, taxes, insurance and homeowners association dues) is no more than 29% of your gross monthly income. Also make sure your total monthly debt (mortgage plus car loans, student debts, etc.) is no more than 41% of your total monthly income.
How To Determine Your DTI Ratio
Mortgage lenders consider DTI an important qualifying factor. The amount of debt you have is considered a very reliable predictor of the risk associated with the approval of any mortgage loan. Therefore, it’s important to know your numbers.
Let’s look at how DTI is calculated.
Step 1: Add Up All Of Your Monthly Debts
Your debt payments could include:
- Monthly rent or house payments
- Monthly child support payments or alimony
- Student loan payments
- Car payments
- Monthly credit card minimum payments
- Any other debts you might have
You don’t need to add in:
- Grocery bills
- Utility bills
- Any other bills that may vary month to month
Step 2: Divide Your Monthly Debts By Your Monthly Gross Income
Next, do a simple calculation. For example, let’s say your debts add up to $2,000 per month. If your monthly gross income (your before-tax income) is $6,000 per month, then your DTI ratio is 0.33, or 33%.
Other Factors That Determine How Much Home You Can Afford
Although DTI and housing expense ratio are important factors in mortgage qualification, there are other things that impact your monthly mortgage payment and how much you can afford.
What follows are several factors to keep in mind before you hit the pavement looking for a new home.
Mortgage term refers to the length of time you have to pay back the amount you’ve borrowed. The most common loan terms are 15 and 30 years, though there are other terms available.
Your mortgage term impacts your monthly payments. Here’s an example:
If you buy a $200,000 house with a 15-year fixed-rate mortgage at 3.90%, your monthly payments are $1,469.37 (excluding taxes and insurance).
Now, let’s change the term. Let’s say you still buy the $200,000 house at 3.90%, but the term is 30 years. Your monthly payments are $943.34 (excluding taxes and insurance).
Once you close on your home loan, your monthly mortgage payment may well be the biggest debt payment you make each month, so it’s important to make sure you can afford it. Along with the down payment, this is probably one of the two biggest factors that determine how much you can afford.
Mortgage Interest Rate
Mortgage rate refers to the interest rate on your mortgage. Mortgage rates are determined by your lender and can be fixed or adjustable. This means they can stay the same or change over the life of the loan. Your rate can vary depending on your credit score, down payment and other factors.
Say you bought the same $200,000 house as above with the 15-year fixed mortgage at 3.90%, but we changed the mortgage interest rate to 4.25% instead. Your payment would go up from $1,469.37 to $1,504.56 per month.
Even a small difference in interest rates could mean hundreds or even thousands of dollars difference in interest paid over the life of the loan. Interest rates also affect your overall monthly payment, which has the biggest direct impact on affordability.
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Your Monthly Budget
Now that you’ve looked at your DTI and any debt you may have, think about your budget. How does a monthly mortgage payment fit in? If you don’t have a budget, keep track of your income and expenses for a couple of months. You can create a personal budget spreadsheet or use any number of budgeting apps or online budgeting tools.
In the mortgage process, it’s important to look at your budget, savings and assets for a couple of reasons. For one thing, you might need savings for a down payment, which we’ll discuss in a later section. However, for now, let’s go over something called reserves. These may be required, depending on the type of loan you’re getting.
Reserves refer to the number of monthly mortgage payments you could make from your savings if you lost your job or experienced another event that impacted your ability to make your payment. Every loan program is different, but a good guideline is to keep at least 2 months’ worth of mortgage payments in your savings account.
Look at your full financial picture after you’ve tracked your income and expenses for a few months. For example, if you realize you have $3,000 left over at the end of each month, decide how much of that could be allocated toward a mortgage.
Alternatively, you could buy a more affordable house. Take some of your extra money and put it toward your mortgage principal every month to pay off the loan faster.
You might think you need to plunk down 20% of your purchase price for a down payment, but that’s actually not true. You can get a conventional loan (a loan backed by Fannie Mae or Freddie Mac) for as little as 3% down.
That’s not to say there aren’t advantages to a higher down payment. For example:
- Lower interest rates: For starters, interest rates are decided on two factors: down payment and median FICO® Score. The higher your down payment is, the better your interest rate will be. If a lender doesn’t have to loan as much money, the investment is considered a better risk.
- No mortgage insurance: If you put down less than 20%, you’ll likely have to pay for mortgage insurance, which can involve a monthly fee as well as an upfront fee depending on the loan option you qualify for. Mortgage insurance protects your lender and the mortgage investor if you don’t make payments and default on your loan.
As you determine how much house you can afford, remember to factor in down payments, especially if you’re trying to afford the 20% to avoid PMI.
Note that you might not have to put down anything at all if you qualify for certain government loans.
In addition to the cost of your down payment and any private mortgage insurance, you’ll also need to consider homeowners insurance, taxes and closing costs:
- Homeowners insurance: Your homeowners insurance amount depends on where you live, your neighborhood and the type of home you buy. Homeowners insurance calculations also consider the value of your property, potential rebuild costs and the value of your at-risk assets. It’s best to call an insurance agent to get an idea of what your homeowners insurance amount could be.
- Property taxes: If you own property, you pay property taxes, which amount to your property’s assessed value multiplied by the local tax rate. You can ask your local tax assessor for more information.
- Closing costs: Closing costs must be paid during closing, the last step in the home buying process. Your lender will give you an estimate of your closing costs. These include the loan origination fee, appraisal fees, title search fees, credit report charges and more. Typical closing costs on a home purchase can be anywhere from 2% – 6%.
Find out what you can afford.
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3 Tips For Buying An Affordable Home
Suppose you qualify for a large home loan. While your lender is willing to loan you a substantial amount of money, that doesn’t mean you have to borrow the entire amount if it would put you under significant financial strain.
Assessing how much you should spend on a house requires a bit of a look into your current and predicted future financial situation. Before you take on the maximum loan you can get and start looking at more expensive houses, consider these tips.
1. Be Prepared For Potential Changes In Employment
If you lose your job, how will you pay your mortgage? When you apply for a mortgage, your lender ideally will want to see a 2-year work history before they grant approval. If you choose to take the largest loan you qualify for, will you be able to make those higher monthly payments during a period of unemployment?
2. Understand Your Mortgage Options
The type of mortgage loan you choose to apply for can affect how much house you’re able to afford. As such, it’s important to have a clear sense of what each loan option will entail as you begin your home buying journey.
- Conventional loan: A conventional loan will allow you to get a home with as little as 3% down. They also can come with lower interest rates than other loan options, such as FHA loans.
- VA loan: A VA loan is a mortgage option available to United States veterans, service members and their (usually) un-remarried surviving. They’re offered by traditional lenders and backed by the U.S. Department of Veteran Affairs. VA loans are no-down-payment loans that offer more lenient income requirements and have no required credit minimum - though most lenders do. Rocket Mortgage® requires a 580 minimum median credit score.
- FHA loan: An FHA loan is a loan that is backed by the Federal Housing Administration. If you have a lower credit score and less money for a down payment, you might qualify for an FHA loan. To qualify through Rocket Mortgage, you’ll need a 580 median credit score and a 3.5% down payment.
- USDA loan: A USDA loan is backed by the U.S. Department of Agriculture. You could be eligible for a USDA loan if you want to buy property in a qualifying rural or suburban area and if you’re a low-to-moderate income earner. You can get a USDA loan with no down payment.
- Jumbo loan: Jumbo loans – also referred to as Jumbo Smart loans – allow you to get a loan amount higher than $726,200, the current conforming loan limit. You'll need a higher down payment – at least 10.01% for loans up to $2 million – and a credit score of at least 680.
All three government-backed loans have mortgage limits, which is a handy way to help you stay in a healthy debt-budget range. At this time, Rocket Mortgage doesn’t offer USDA loans.
3. Plan For Emergencies
Emergencies strike when you least expect them – unexpected medical treatments, sudden job loss, a flooded basement, a car on the fritz. Putting all your extra funds toward mortgage payments instead of saving for a rainy day can spell disaster.
Having an emergency fund can be a good safety net for anyone, but especially for new home buyers. A good rule of thumb is to sock away 3 – 6 months’ worth of expenses. Your emergency money can go toward paying your mortgage if need be, and having it set aside can give you a little more peace of mind when determining how much you can realistically afford to pay for a house.
The Bottom Line: Deciding How Much House You Can Afford
Ultimately, how much home you can afford depends on your financial situation and preferences. It requires a more comprehensive decision than just how much money you want to spend on mortgage payments each month.
Evaluate your full financial situation, your ability to pay off a mortgage and where you need to save for other things. Once you’ve done all that, it’s time to go after that perfect home.
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