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.