How Much House Can You Afford?
We first published “How Much House Can You Afford” over a year ago, but we’ve been getting a lot of questions about the subject recently. In fact, we’ve also been getting a lot of people asking why they haven’t been approved for a mortgage. In many cases, we simply have to tell them that they’re trying to buy too much house. The easy solution is to know how much house you can afford before you apply for a mortgage.
Buying your first home is one of the most important and exciting financial milestones of your life. But before you hit the streets with a realtor, you need to have a good sense of a realistic budget. Just how much house can you afford? You can determine how much house you can afford by following three simple rules or percentages of your monthly income.
The Rules of Home Affordability
Mortgage lenders use something called qualification ratios to determine how much they will lend to a borrower. Although each lender uses slightly different ratios, most are within the same range. Some lenders will lend a bit more, some a bit less. We have taken average qualification ratios to come up with our three rules of home affordability.
Your Maximum Mortgage Payment (Rule of 28): The golden rule in determining how much home you can afford is that your monthly mortgage payment should not exceed 28 percent of your gross monthly income (your income before taxes are taken out). For example, if you and your spouse have a combined annual income of $80,000, your mortgage payment should not exceed $1,866.
Your Maximum Total Housing Payment (Rule of 32): The next rule stipulates that your total housing payments (including the mortgage, homeowner’s insurance and private mortgage insurance (PMI), association fees and property taxes) should not exceed 32 percent of your gross monthly income. That means for the same couple, their total monthly housing payment cannot be more than $2,133 per month.
Your Maximum Monthly Debt Payments (Rule of 40): Finally, your total debt payments including your housing payment but also auto loan or student loan payments and minimum credit card payments should not exceed 40 percent of your gross monthly income. In the above example, if the couple with $80k income wanted the highest mortgage payment they could get, they could have up to $533 in other debt (car payments or credit cards).
This rule means that if you have a big car payment or a lot of credit card debt, you won’t be able to afford as much of a mortgage payments. In many cases, banks won’t approve a mortgage until you reduce or eliminate some or all other debt.
How to Calculate An Affordable Mortgage
Now that you have an idea of how much of a monthly mortgage payment you can afford, you’ll probably want to know how much house you can actually buy. Although you cannot determine an exact budget until you know what interest rate you will pay, you can estimate your budget. Assuming an average six percent interest rate on a 30-year fixed-rate mortgage, your mortgage payments will be about $65 for every $10,000 borrowed.
- $1,866 / $65 = 28.71
- 28.71 x $10,000 = $287,708 (Your maximum mortgage amount)
Include Your Down Payment: Hopefully you have a down payment of at least 10 percent up to 20 percent of your future home’s purchase price. Add that amount to your maximum mortgage amount, and you have a good idea of the most you can spend on a home. Note: If you put less than 20 percent down, your mortgage lender will required you to pay private mortgage insurance (PMI), which will increase your non-mortgage housing expense and decrease how much house you can afford.
Ready To Go House-Hunting? Save time, money, and aggravation by lining up your financing first with a mortgage pre-approval. Read my post on how to get no-obligation mortgage quotes online.
Related Posts
- What Percentage of Income Can You Afford for Mortgage Payments?
- Are You Ready to Buy a Home? An Easy Way to Check
- How to Find the Best Mortgage
- Your First Mortgage: How to Apply and Get Approved
- How to Buy a House or Condo Immediately After College
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There are so many rules to buying a house. I Think these are very valid points but the fundamental concept of purchasing a house should be a payment which you are comfortable making for 30 years. Taking into account your house will cost more than just the mortgage, you have garbage pick up, utilities, power, there is sooo much more.
If you do use one of these rules keep in mind just because the rule states you can handle an $1,800 payment does that mean you should? What if something happens and you lose wiggle room, that extra money you spent purchasing that third garage and 5th bedroom could really come in handy at that point.
I lucked out when buying my house, prices in Texas are low. I feel bad for my friends in New York where they can’t find much for $300,000. I’m not sure how people making 35-45k can afford to live up there.
One issue is that in some very expensive metropolitan areas (New York, Boston, San Francisco, etc.) it may be necessary–and common–to stretch farther if you ever want to get in the game at all. In a lot of these places, it still makes sense to suck it up for a couple years and eat a lot of ramen, especially if you anticipate making more money down the road (like if you’re still in an entry level job, but have good career prospects). It can even be fun; invite your friends over to enjoy your new digs instead of spending the money out at bars!
This *is* what I did, though I don’t necessarily advocate it for everyone… but it certainly make sense for some.
Another figure to use is the pre-qualification that the mortgage companies will give. A quick rule of thumb from when I worked in real estate was that the average buyer with typical credit should be able to afford a loan equal to about four times their gross annual income. So for example, if you make $50,000 a year and you have $50,000 for a downpayment, your affordability calculation would be 50k*4=200k, plus $50k=$250k purchase price. However this tends towards the high side compared to the calculations you note above, so I like to do both of them and compare the difference to use as the “range” of what your affordability is in an expensive market.
I should note that in some *very* expensive markets, lenders sometimes allow a debt-to-income ratio of up to 65%! Yikes!
It’s because of all the people that live in the expensive metropolitan areas (New York, Boston, San Francisco, etc.) who have “stretched farther” to buy a house that we are in this current financial crisis. These people were barely able to make thier payments and then something happens (job loss, accident, rising interest rates on ARMS) and all of a sudden they cannot afford thier house. They get forclosed on and the entire country ends up in a mortgage crisis.
My advice, figure out a solid budget for at least half a year before planning to buy. Make sure you know exactly how much you can afford to pay each month still leaving room for savings. That’s what my fiance and I did. We bought a smaller house and are comfortable making the payments and still able to sock away quite a bit for savings and investments each month.
“It’s because of all the people that live in the expensive metropolitan areas…”
States with highest foreclosure rates (January 2009): Nevada, California, Arizona, Florida, Oregon
http://www.usatoday.com/money/economy/housing/2009-02-11-decline-housing-foreclosure_N.htm