Hey there! Are you in the market for a house? Have you ever wondered how much house you can afford comfortably? While a simple calculator can help you figure out how much a bank would be willing to lend you, the truth of the matter is, many things go into figuring out how much house you can afford.
Finding a dream home is exciting. My wife and I look through listings all the time, even when we're not in the market. With that in mind, just because you may be able to afford a dream home on paper, doesn't mean it's the best idea. When determining how much house you and your husband or wife can afford, there's several things to take into consideration.
In this post, I'll provide many things you should take into consideration when you ask yourself, “How much house can I afford to live comfortably?” Read on for details for:
- What a calculator will provide you
- What a financial expert may tell you
- What to take into consideration
- What mortgage debt means on a broad scale
- How your lifestyle affects how much house you can afford
- How buying less house can give you more wiggle room
Let's get started!
What a “How Much House Can I Afford” Calculator Will Tell You
A house is generally the largest purchase you'll ever make. There are multiple factors that go into how much house you can afford, including your gross monthly income from all sources, your monthly debt, the estimated annual taxes and insurance of your home, and more. The calculator may not tell you the closing costs, as they vary greatly by lender and location.
A calculator will tell you how much you could borrow. Most lenders use the 28/36% rule, which says you should not spend more than 28% of your gross monthly income for your mortgage, taxes, and homeowner's insurance, and also no more than 36% on total monthly debt payments combined. This is also called your debt to income ratio. This calculator at Bankrate will give you an idea of what you can borrow from a typical lender if you meet other credit qualifications.
In short, when determining how much house you can afford based on your gross income, the general rule of thumb is a housing payment of 28% of your gross monthly income, max.
That said, just because a lender will lend you a certain amount of money, it doesn't mean you should take on that much debt. To calculate how much house you can afford or how much house payment you can afford, simply take you and your spouse's salary, divide by 12 and multiply by 0.28. This will give you your maximum monthly house payment, which consists of your mortgage, HOA fees, taxes, insurance, and PMI.
There are other factors that go into how much house you can afford to live comfortably. Let's go into that next.
How Much House Can I Afford To Live Comfortably?
While most lenders will make decisions based on the 28/36% rule, it's also important to consider other factors when determining how much house to buy. If you have a lifestyle where you spend a lot on entertainment, travel, or services such as memberships and/or high-speed internet, your living expenses may require you to borrow less money. You have to be able to pay the monthly mortgage payment, of course!
When in doubt, always examine your budget before deciding how much a bank is offering to lend you for your home loan. For example, if your lender pre-approved you for a $300,000 loan and assume your interest rate was 3.22% with a 30-year term. Adding in an estimated $55 monthly homeowner's insurance payment and a $645 property tax rate, this would put you at $2,000 per month for your mortgage.
Now, assume you and your spouse have a gross monthly income of $8,000. If you do some quick math, you'll see $2,000 is 25% of $8,000, which follows the 28/36% just fine. But, what if after taxes and deductions at work, your $8,000 was only bringing in $5,500. Now that leaves you with $3,500. Assume you have a hefty budget for groceries, utilities, transportation, clothing, entertainment, lawn care, childcare, and more. All of a sudden, you don't have as much money to play with.
This is why it's crucial to review your budget in its entirety while determining how much house you can afford.
Paying Off Debt Before Buying a House
It's wise to pay off as much of your other debt as possible before buying a house. Other debt includes car loans, credit card debt, and student loans. Paying off your debts has an added benefit of raising your credit scores, which will encourage mortgage lenders to give you better rates, and by being in less debt, you can afford more home.
How Much Should You Put as a Downpayment on Your Home
It is almost always best practice to put 20% or more as a down payment on your home. This is to avoid paying private mortgage insurance (PMI), which can cost you extra each month until you reach 20% equity. Private mortgage insurance protects the bank in case you default on your mortgage.
How Much Your Mortgage APR Adds Up
When deciding how much house to buy, you also want to determine how the mortgage will cost you long term. A home price of $360,000 with a 20% downpayment ($60,000) gives you a $300,000 mortgage. With the mortgage rates above (3.22% APR with a 30-year term), this mortgage would cost you an additional $168,246 in interest payments over the life of the loan.
You would be in debt to a financial institution for 30 years, meaning if you had a financial hardship and couldn't work something out, the bank could foreclose on you and take your house.
By buying less house, you may have the ability to pay extra each month, which cuts down your total interest payments and shortens your loan term.
Your Lifestyle and How Much House You Can Afford
As mentioned above, your lifestyle influences how much house you can afford. If you are a minimalist or you live frugally, you can afford more house because you are likely maximizing your savings rate. That said, you might not want to use that as an excuse to buy more house necessarily.
If you are more of a spendthrift, you'll have to be cautious with borrowing money for a house. Being foreclosed on is a devastating event, and poor spending and savings habits is a sure ticket to financial ruin if you borrow more money than you can afford to pay back.
Use this home affordability calculator from Bankrate to get more information on how much you can afford before buying a home.
Buying Less House to Give You More Wiggle Room
Buying less house has its perks. When you buy less house, you have more money for wiggle room. That money can be used to invest in yourself, whether it be investing in your retirement plan, taking courses to further your career, learning a new skill, or finding a fun hobby. If something goes wrong in life, you'll have more money available to handle it.
It always pays to have more cash on hand, and most people don't truly need as much house as they think they do.
Can I Borrow 5 Times My Income?
In the UK, you can often borrow 4.5 to 5 times your income, however, in the USA, your total monthly payment between your mortgage, HOA fees, insurance, taxes, and PMI, should be less than 28% of your gross monthly pay.
What Deposit Do I Need for a Home Loan?
Traditionally, banks are looking for a 20% down payment on a home. When you put less than 20% down on a house, you are generally charged PMI (private mortgage insurance), which you'll be responsible for until you have 20% equity in your home.
It's a better deal to buy a house with less than 20% down in some situations. This could be if you've found a great deal on a house or rent in your area is very high.
For cashflow reasons, it's better to put 20% down a house when possible. This will lower your monthly payment for the life of the mortgage, which is great in the future if your income drops temporarily.
Wrapping It Up
Looking into buying a house is exciting, and the day you walk into your new home is amazing! With all that goes into the process of purchasing your new home, make sure you take steps from the beginning to ensure you're not buying too much house. Use both a mortgage calculator and review your budget closely to determine how much house you can afford.
What types of compromises did you make when purchasing the home you live in or will live in one day?