How much can I afford when buying a home?
When deciding how much you can afford when buying a home, you’ll have to factor in costs like your income, the sales price, down payment, interest rate, loan term, total monthly debts, closing costs, common expenses and even the state the home is located in. Working with a loan officer who can help you find a mortgage that will take all these factors into consideration is critical for your financial health, and ability to stay on track of your monthly payments.
Because everyone’s income and expenses vary, it’s a good idea and a general rule of thumb to devote no more than 28% of your gross yearly income towards your mortgage. You’ll also want to have a little extra in your monthly housing budget to cover regular expenses like repairs, and annual fluctuations in insurance and property taxes. If you’re ready to invest in a property—an investment that could reward you in the long run—keep reading to find out what you may afford.
Income
Probably the most important affordability factor, your income will determine not only how much you can buy, but how much you can borrow.
To get your gross income, add your total earnings for the year before taxes, then divide by 12.
Eligible income sources not only include your employee wages and salary, but can include:
Bonuses, commissions, and tips
Self-employed or freelance income
Court-ordered alimony and child support
Disability payments
Foster care income
Investment returns and trust income
Rental or property income
Retirement and pension income
Social security payments
VA benefits and military income
Not all of the above are considered for all loan programs to determine your eligibility. Your loan officer can advise on the best home loan program for you based on your income. If you’re looking for a ballpark estimate for how much home you can afford, try our mortgage income calculator which will give you an idea of how much you’d need to earn to buy the home you want with a mortgage.
Down Payment
Your down payment, also known as the amount of the home purchase price paid upfront, is a major factor in your ability to afford a home. It’s simple: if you provide more down payment upfront, you’ll likely have a lower monthly payment (and even a better interest rate). The inverse is also true: you could benefit immediately from a low or even zero down payment upfront, but you may have to pay more every month and/or deal with a higher interest rate. Plus, if you provide less than a 20% down payment, you’d also have to purchase private mortgage insurance (PMI) if you’re looking at conventional financing options and pay it as part of your mortgage every month.
Your loan officer can walk you through different financing scenarios, such as how much your monthly payment would be if you provided a higher down payment amount, or whether you qualify for any down payment assistance programs.
Interest rate
The interest rate on your mortgage will have a major part in figuring out how much you can afford to buy. There are a variety of factors that account for your interest rate. Some are within your control, such as your credit score, home location, down payment and your current debts. Other factors on the loan level can be your loan term, type of loan program, your lender and whether you choose and fixed-rate versus adjustable-rate mortgage (ARM) and discount points.
Finally, well outside your control, is the overall economy which sets the par mortgage rate. The par rate corresponds to the health of the US economy as well as investor confidence. Though interest rates can be a hot topic in political and economic circles, as a homebuyer it’s best to focus on what you can control, and keep in mind you can refinance your loan with a different rate in the future.
Loan term
Your loan term will affect how much you can afford when you’re buying a home. Depending on the loan program, you can expect to be making payments for anywhere from 5 to 30 years. Interest rates play a factor in the terms as well). With a fixed-rate mortgage, you’ll be able to accurately predict your monthly future payments, and the most common term is 30 years though you could also select 10 years. An adjustable-rate mortgage (ARM) can provide a lower initial payment during the term’s introductory period, but will vary afterwards, as the rate will vary based on the market. An ARM’s initial fixed-rate period lasts from 5-10 years.
Total monthly debts
Your total monthly debts, and your debt-to-income ratio (DTI), is a major factor in determining your home affordability. Monthly debts include recurring monthly payments or outstanding debts including loans, credit lines, child support, and minimum payments for credit cards and other mortgages. Student loans apply as debt but may be treated differently depending on which loan type you decide to use for a mortgage. Rent, utility bills and insurance premiums are not part of this debt.
The DTI ratio is the percentage of your debts to your total income. Generally, you’ll be more likely to be approved for a mortgage with a debt-to-income ratio of 36% or lower, but this will depend on your mortgage loan. With some lenders, your DTI can be as high as 50% if your credit score is sufficient.
Closing costs
When determining how much you can afford, you’ll need to factor in closing costs, which are one-time fees and the first of various recurring payments that you’ll need to pay on closing day.
These costs are usually 2-5% of the home’s value. Some one-time fees could include origination, appraisal, processing, underwriting, settlement agent, title and recording fees, and discount points (if applicable). You’ll often make your first payment on closing day for property taxes and homeowner’s insurance, which you’d be paying off monthly as part of your mortgage.
There is a possibility you and the seller could negotiate certain closing costs. The seller may pay a portion of the buyer’s costs to make the property more attractive.
We offer a closing cost calculator where you can easily estimate how much you can afford when you close on your mortgage.
Common expenses
If you’ve been a renter, you’ll have to consider whether you’d be able to afford expenses for home repairs or maintenance as a homeowner. Monthly household expenses, like utilities, private mortgage insurance or HOA fees would also need to factor in your overall budget. How much do you estimate your moving expenses would be? These are also other important costs to factor in your overall budget when it comes to affording a home.
Overall, the National Association of REALTORS© (NAR) recommends that you save one to four percent of your home’s value for annual maintenance and repair costs, some of them preventative. This will of course vary depending on the age of your home.
State
Everything from your home’s property taxes, homeowner insurance, utilities, and cost of living will vary depending on where your new home is located. If you’re considering living in a densely populated area or major city, you can expect to pay more for utilities and your general expenses. Even if you want to live somewhere remote, you may have to consider whether the home may be in an area that’s frequently rattled by earthquakes, tornadoes or hurricanes, which would drive up your insurance rates and require you to get separate hazard insurance. Property taxes can vary widely even within the same state, with California as a prominent example.
If you’re ready to take the next step, you can get pre-approved for a mortgage today. This step is free, and one of our loan officers can help you determine just how much you can afford to get started on your homebuying hunt. There’s a lot to consider when it comes to figuring out how much you can afford, and we can help you tackle one step at a time with precision.