How much should you spend on a house?

Buying a house is a big deal. One major part of the process is figuring out your budget and how much you can spend on the home. The good news is that with a bit of knowledge and some popular rules of thumb, you can easily figure out how much house you can afford.

Step 1: Determine how much home you can afford

The first thing that you should do when trying to determine if you should buy a house is to track your income. Add up all of the money you make from your job and any side gigs, then add your partner’s income if you’re buying a home with someone else.

Once you know that, you can start thinking about how much of your income you can dedicate to a housing payment.

A good way to get started with that is to use a popular rule of thumb: the 28/36 rule.

The 28/36 rule

The 28/36 rule is a rule of thumb that financial experts use when advising people on their spending and debt. The rule refers to two percentages. It recommends that people spend no more than 28% of their before-tax income on housing expenses and 36% of their total before-tax income on debt service, which includes housing and other loans such as auto loans, student loans, or credit cards.

Others recommend keeping housing expenses to 33% of your income.

If you’re in the market for a house, this rule can be a solid way to get a quick sense of how much home you can afford. For example, if you earn $7,000 a month, you should aim to spend no more than $1,960 a month on housing, which includes your mortgage, insurance, property taxes, and PMI. You should also aim to spend no more than $2,520 on total debt service.

Spending more on your mortgage each month risks leaving you house poor, with too much of your monthly income going toward your home.

Keep in mind that this is simply a rule of thumb. In some cases, you can safely extend beyond these limits, and in others, you should try to stay below them. It all depends on your unique situation.

These rules of thumb tie in closely to the idea of your debt-to-income ratio. Your DTI ratio is a numerical representation of how much of your income you spend on recurring debts each month.

When reviewing your mortgage application, a lender will look at your DTI ratio to determine if you can afford to take on more debt. Your DTI ratio can also help you decide whether you should be renting or buying at this time.

Step 2: Calculate your debt-to-income ratio

Calculating your DTI ratio isn’t hard, but you’ll want to set aside a bit of time to gather the necessary information.

To start, add up all of your current monthly debt payments in your debt calculation. Your debt obligations might include:

• Rent
• Student loan debt
• Auto loan payments
• Personal loan payments
• Minimum payments on any credit cards in your possession
• Child support payments or alimony

You don’t need to include groceries, utility bills, and taxes, which can be more variable.

After adding up your monthly debt payments, divide by your gross household income. Then, multiply that number by 100 to convert the result to a percentage.

For example, suppose your total monthly debts equal $2,000 and your gross monthly household income is $5,000. To find your DTI, just divide $2,000 by $5,000. In this example, your DTI is 0.40, or 40%.

When you buy a home, you’ll replace the rent portion of your DTI ratio with a mortgage payment, so it’s worth running the calculation with your potential mortgage payment plugged in. However, keep in mind that rent doesn’t include some costs of homeownership, like private mortgage insurance, or maintenance.

In general, the lower your DTI ratio, the better. If your DTI is greater than 50%, you’ll have a tough time finding a loan. While it’s not impossible to get a mortgage with a high DTI ratio, you may want to take some time to reduce your debt before applying instead.

Step 3: Estimate how much you can spend on a home

If you’re sharp-eyed, you might have noticed that so far, we’ve only discussed the monthly cost of your mortgage and how it fits into your budget. However, when you’re out shopping for homes, you’ll make an offer in a flat dollar amount rather than a monthly payment.

You need some way to convert the price of a home into a monthly cost to see whether you can afford it. The three main factors that affect the monthly cost of a mortgage payment are the amount you borrow, the mortgage repayment term, and the interest rate.

Calculate your down payment and amount to borrow

The first factor influencing your mortgage’s monthly payment is the amount you borrow. That’s impacted by two factors: the price of the home and your down payment.

Your down payment is the upfront amount you pay when buying a home, typically using cash or other liquid assets you’ve saved. Most mortgages require some down payment, with 3% the minimum on a conforming conventional loan. Larger down payments mean borrowing less money, which makes you more appealing to lenders and makes it easier to qualify for a loan.

If you can offer a 20% down payment, you can usually avoid PMI, which further reduces the cost of homeownership.

To determine how much you’ll need to borrow to buy a home, subtract your down payment amount from its price.

Check your mortgage repayment term

Your mortgage repayment term is the length of your mortgage in years. If you have a term of 30 years on your loan, you’ll make a payment every month for 30 years. After that, you’ll have paid the loan off and own your home free and clear.

The most popular mortgage repayment terms are 15 years and 30 years. However, lenders can create custom loan terms. At Rocket Mortgage®, you can get a repayment term as short as 8 years.

A longer term lowers your monthly payments, possibly letting you buy a more expensive home. However, you’ll pay more interest over time.

Compare interest rates

Your interest rate depends on a number of factors, including your credit score, your loan structure, and current market conditions. The lower the interest rate of your loan, the less you’ll pay each month.

Even a difference of a tenth of a point in interest can mean paying thousands more for your loan over time, so it’s worth the effort to shop around to get the best rate possible.

Step 4: Consider all the costs of homeownership

Your monthly mortgage payment is a big deal and one of the more important things to keep in mind when deciding whether you can afford a home, but there are other very important costs that can make or break a home’s affordability.

Closing costs

Closing costs are one-time expenses you pay when you close on your loan. Closing costs include the appraisal, home inspection, title insurance, and attorney fees, among other costs. Expect to pay 2% – 6% of the loan amount in closing costs.

Mortgage insurance

If you use a conventional mortgage and buy a home with less than a 20% down payment, you must pay PMI, which protects your lender if you default on your loan.

You can usually cancel PMI once you reach 20% equity in your home.

If you use an FHA loan instead of a conventional loan, you’ll be responsible for paying mortgage insurance premiums for at least 11 years after taking out the loan. If you made a down payment of less than 10%, you’ll be on the hook for MIP for the life of the loan.

Both of these forms of mortgage insurance increase your monthly payment, which you need to account for when deciding if a home is affordable.

Homeowners insurance

Homeowners insurance isn’t a legal requirement to own a home. However, most mortgage lenders require borrowers to buy a policy.

Homeowners insurance protects you against damage to your home from hazards such as fires, break-ins, and lightning storms.

Your homeowners insurance rate will vary depending on your individual circumstances, but you can expect to pay $93 – $246 per month for your premium depending on the size and location of your house.

Property taxes

Every homeowner must pay property taxes to their local government to fund establishments such as public schools, libraries, and emergency services. Your property tax rate will vary depending on where you live.

If you’re shopping for a home in a specific town or county, know the effective tax rate to estimate your tax liability.

Maintenance

When you own a home, you’re responsible for keeping it well-maintained. While you can DIY it if you’re handy, you’ll want to set aside some money to pay for more extensive repairs and fixes.

Appliances, roofing, flooring, and paint are just a few of the things you’ll need to remember to upgrade, repair, or replace on a regular basis to keep your home in good condition.

A popular rule of thumb is to budget 1% to 4% of your home’s value for maintenance each year, depending on things like the age, location, and condition of your property.

Imagine you own a home worth $300,000. That means you should budget anywhere from $3,000 to $12,000 per year, or $250 to $1,000 per month, for upkeep.

Keep in mind that these are averages. Some years might see you spend less than this amount if you’re only doing routine upkeep and care. Other years with larger maintenance projects, like replacing a roof or HVAC system, might see you spend more.

Utilities

Utilities are another monthly cost to keep in mind. You’ll need to pay for things like heating, electricity, water, trash removal, internet, and more. It’s easy to forget about these costs, but they can add up quickly, so it’s important to keep them in mind when deciding if a home is affordable.

All-in-all, expect to spend between $200 and $400 a month on utilities, depending on where you live, the size of your home, and how energy-efficient the home is. You can reduce these costs somewhat by making energy-efficient improvements, like adding insulation to your attic.

Homeowners association fees

Some homes are part of a homeowners association. These organizations are common for condos, co-ops, and gated communities, though they can also exist in neighborhoods of single-family homes.

HOAs provide valuable services, such as maintaining public amenities like pools and recreational spaces, handling lawn care and snow removal, or maintaining the exterior and roof of a multi-unit condo.

Step 5: Compare homeownership costs against your budget

Now that you know the full cost of homeownership and have a rough idea of how much you can afford to spend a month, consider your household expenses. Before committing to a mortgage, you need to be sure you can afford your mortgage, insurance, and tax payments.

If you don’t already have a household budget, take the time to track your expenses for a few months and see where your money is going. Look at how much you have coming in and compare it to the cost of homeownership. Remember, as a general rule, your homeownership expenses shouldn’t consume more than 28% of your monthly budget.

If your anticipated homeownership expenses take up more than 28% of your monthly budget, you’ll need to adjust your mortgage choice. A longer mortgage repayment term or buying a less expensive house can lower your monthly payment.

The bottom line: Tips for affording a house

Buying a home is a big commitment and it’s important to feel like the house you’re buying is the home of your dreams. While it’s important to be realistic about what you can afford, there are things you can do to find a great home and keep it within your budget.

Ready to buy a home? Start your mortgage application with Rocket Mortgage today.