The prospect of purchasing a home is exciting. Pounding the pavement in search of a home that you’ll someday call your own can be a fun and rewarding experience.
But trying to figure out how much you can actually afford can sometimes take the fun out of the home shopping experience. That said, it has to be done. After all, you don’t want to waste your time searching for homes in a certain price range if you’re really only able to afford something cheaper. Not only that, you’ll avoid any disappointment by finding out how much you can afford first, then focusing on properties that fall within your budget.
Many homebuyer hopefuls often ask themselves, “How much house can I afford?” And that’s an important question to ask, because the answer you get will help ensure that your house hunt is a much more streamlined process. Not only will you know how much you can afford in terms of a mortgage, but also in closing costs, maintenance costs, repairs, utilities, and other expenses related to homeownership.
How Much House Can I Afford?
To get the answer you’re looking for, it helps to understand how lenders assess borrowers’ ability to afford a mortgage of a certain amount. Before you’re approved for a mortgage, your lender will thoroughly assess your financial situation to make sure you’re able to comfortably afford to make your mortgage payments while still being able to pay any other debt obligations that you might have.
The following factors play a focus role in helping lenders assess your eligibility to secure a mortgage, as well as the amount you would actually be able to afford.
Read more: Should I Rent or Buy a House?
Your Credit Score
One of the first things that your lender will do is pull your credit report. Your credit report tells lenders what your payment behavior has been like in the past. For instance, missed debt payments will pull down your credit score. In this case, you would be considered more of a risk in the eyes of your lender.
On the other hand, a clean record of timely payments will bring your score up and will make you less of a risk to lenders. As such, you would likely have an easier time getting approved for a mortgage at a lower interest rate.
In addition to your payment history, your credit score is also based on how much debt you have, the types of credit you have, the number of accounts you have open, and the length of your credit history.
Your Debt-to-Income Ratio
The amount of debt you are currently carrying relative to your net income is referred to as your debt-to-income ratio (DTI). This is an important number that your lender will use to assess your ability to handle an additional payment in the form of a mortgage in addition to all the other debt obligations you have.
This ratio is represented as a percentage and is calculated by dividing your monthly debt by your monthly income. For instance, if you earn an income of $5,000 per month and pay $2,000 in debt payments, your DTI would be 40%. Lenders typically like to see DTI ratios no higher than 43%. The higher that number is, the riskier you’ll be for your lender.
Lenders use this calculation to make sure you’ve got enough of a steady income to comfortably cover your new mortgage payment while still making your other monthly debt payments on time every month.
Your Down Payment Amount
The more you can save money to put towards your home purchase, the better. A higher down payment amount means you’d have to borrow less money to buy a home and would require less financing to make that deal happen. Not only that, but a higher down payment amount means you may be able to afford a more expensive house.
Conventional loans typically require a minimum down payment of 5% of the purchase price of a home, though you can avoid paying Private Mortgage Insurance (PMI) premiums by putting at least 20% down. PMI payments will have to be paid along with your mortgage until your loan amount dips under 80% of the market value of your home. In this case, you’d be saving an extra payment each month by making a minimum 20% down payment.
Other mortgage types require smaller down payment amounts. For instance, FHA-backed home loans require a minimum of 3.5%. There are even some mortgage arrangements – such as VA loans and special programs for first-time homebuyers that require no down payment.
Regardless of the minimum down payment amount required, you’d be better off putting down as much as you can, well above any minimum requirements. That’s because a higher down payment amount will reduce your loan-to-value (LTV) ratio, which is a measurement of the loan amount you take out versus the market value of the property. The closer the loan amount is to the property’s value, the higher your LTV will be.
Borrowing most of the purchase price amount will mean you’ve got less equity in the home, which puts you at a higher risk of defaulting on your mortgage if you ever fall upon hard financial times. A higher loan amount will also mean that you’ll have to pay more towards the interest portion of your mortgage, which makes your home loan even more expensive.
In any case, your down payment amount will help determine your eligibility to secure a mortgage as well as how much you’ll be able to afford when it comes time to make a purchase.
How to Calculate Your Housing Affordability on Your Own
Your lender will be able to tell you how much you can afford after you’ve supplied pertinent financial documents and your credit history has been assessed. But you can also make these calculations yourself by taking the following steps:
- Add up your total monthly income. Factor in your income and any income your partner earns, if applicable, minus any taxes or other deductions. Consider any dividends that you make from investments, rent you make from any rental properties you might have, and so forth.
- Get a rough estimate of the monthly mortgage payments you’d be comfortable with. While there are a few ways to do this, one simple way is by multiplying your monthly income by 25%. The number you get is a rough idea of the maximum mortgage payment you’d be able to manage based on your total net income. For instance, if your household income is $7,000 per month, your estimated maximum mortgage payment would be $1,750. Of course, this is just a rough estimate which will be influenced by other factors.
- Use a mortgage calculator to come up with your budget. You can use a handy house affordability calculator like the one Dave Ramsey uses to figure out how much you can afford.
- Consider all costs of homeownership. Owning and operating a home requires a lot of money. There are plenty of costs involved with owning a home that you need to consider in order to establish your true price maximum. Some costs you should factor into the equation include:
- Maintenance fees
- Costs associated with repairs
- HOA fees (if applicable)
- Homeowner’s insurance
- Property taxes
- Home improvements
- Furniture and decor
There are several costs associated with homeownership that need to be considered, so make sure you’ve included them all in your calculations.
What Are the Cheapest Versus Most Expensive Places to Buy a Home in the US?
Now that you’ve got the foundation to figure out how much house you can afford, you might want to know where your dollar can stretch the farthest versus the places that make housing affordability more difficult.
Top 10 Cheapest Places to Buy a House
- Fort Wayne, Indiana – Average home price: $96,200
- Gulfport, Mississippi – Average home price: $121,000
- Pittsburgh, Pennsylvania – Average home price: $122,600
- Buffalo, New York – Average home price: $125,500
- Cincinnati, Ohio – Average home price: $145,400
- Detroit, Michigan – Average home price: $146,204
- Tulsa, Oklahoma – Average home price: $151,400
- Columbia, South Carolina – Average home price: $156,400
- Lexington, Kentucky – Average home price: $157,700
- Chattanooga, Tennessee – Average home price: $167,700
Top 10 Most Expensive Places to Buy a House
- San Francisco, California – Average home price: $1,715,000
- Manhattan, New York – Average home price: $1,611,000
- San Jose, California – Average home price: $1,070,000
- Honolulu, HI – Average home price: $746,000
- San Diego, California – Average home price: $564,000
- Boulder, Colorado – Average home price: $548,400
- Los Angeles, California – Average home price: $485,800
- Long Island, New York – Average home price: $443,200
- Naples, Florida – Average home price: $435,000
- Seattle, Washington – Average home price: $422,100
Clearly, there’s a huge price range among the more expensive versus the cheaper places across the country. If you’re in the position to be flexible enough to move where the cost of living is cheaper, your money can go a lot further. Or else, you can use these numbers to determine how much income you’d need to earn in order to afford to live in specific places across the US.
Knowing exactly how much you can afford in a home is extremely important before deciding to put an offer on a property. It will not only help you narrow your focus, but it can also help you avoid disappointment. You can always calculate your housing limit on your own or get pre-approved for a mortgage to have that number calculated for you.
Either method will give you an idea of how much you can afford when it comes time to buy a home. But you may want to consider buying a home that’s much less than what your calculations dictate. Doing so will help leave a cushion to fall back on should any costs associated with operating a home increase.