How much house can I afford?
Last updated: July 2022
If you're considering buying a house soon, you probably have a list of desired features and have carefully thought about what you want out of a home. The financial responsibility of owning a home is a major commitment, so before you start seriously looking at houses, it's important to carefully assess your finances. This home affordability calculator looks at your entire financial situation to help you determine how much you can realistically spend on the home of your dreams.
How to calculate home affordability
If you've ever wondered can I afford a house, you're not alone. To figure out how much home you can afford, you need to paint a complete picture of your financial landscape. Consider your income, cash on hand for a down payment and closing costs, credit score, regular debt payments, monthly expenses and estimated monthly payment to see what you can afford.
What is an estimated monthly payment?
One of the first things you should do is calculate your expected monthly payment. Monthly payments typically consist of the following, according to Bankrate:
- The principal is the amount of money you begin paying back to your lender.
- The interest is a percentage of the principal.
- Homeowners insurance is required by most lenders and protects your home, structures on your property, your personal belongings and liability.
- Property tax is charged by your local government to pay for schools, roads and public services.
If you put less than 20% down on a home, your monthly payment will also include private mortgage insurance (PMI) to help protect the lender in case you stop making payments, says Forbes.
What is gross annual income?
Gross income is the sum of all your earnings before taxes, according to the IRS. Annual gross income is how much you make in a year, and it plays a significant role in how much house you can afford. You can typically afford higher monthly payments as your income increases. However, annual gross income is just one factor in home affordability.
What is a housing ratio?
A housing ratio describes what percentage of your income you would be spending on a mortgage payment, according to Rocket Mortgage. Lenders use this figure when they evaluate whether to approve or deny a loan request. Typically, they want a housing ratio to be 28% or lower, which means no more than 28% of your income should go toward house payments. Lenders may think your finances would become too stretched by a mortgage if your housing ratio is above 28%.
What are monthly debt payments?
Monthly debt payments, like credit cards, car loans, student loans, rent or mortgage on other properties, are any regular payments you must pay back to a lender, according to Forbes. The more your debt increases, the less house you can typically afford because of something called debt-to-income ratio.
What is a debt-to-income ratio (DTI)?
Debt-to-income ratio is the sum of your monthly payments divided by your monthly gross income, according to Consumer Financial Protection Bureau (CFPB). Almost everyone has a credit card, car loan, or student loans, so your debt ratio will almost always be a higher percentage than your housing ratio. Lenders typically want your debt-to-income ratio to be 36% or below. Paying off debts and lowering your DTI can help boost your chances of being approved for a mortgage.
What is a down payment?
A down payment is the amount of money you pay upfront for an expensive purchase, like a house, you can’t afford outright. Down payments are typically part of a loan or payment plan where the remaining money you owe is divided into more manageable, regularly scheduled payments. Typically, the more you put down, the lower your loan will be, says the CFPB.
What are the terms of a loan?
Loan terms describe all the details of your loan, according to Forbes. These details include your payment due date, payment amount and annual percentage rate (APR).
What is APR?
APR reveals how costly your loan is by combining your interest rate and related finance charges into one convenient percentage, allowing you to shop around and compare loan choices more easily.
If you’re able to find loan terms that work well for you, purchasing a house can feel more affordable. A convenient payment date could mean your bank accounts feel less stretched when a payment is due. A low monthly payment keeps more money in your pocket each month, and a low APR means your costs for borrowing money are relatively low.
What is an interest rate, and how is it calculated?
Interest is essentially a fee for borrowing money. When a lender allows you to borrow a large sum, you’re responsible for paying that amount of money back plus interest. Interest is typically displayed as a percentage called an interest rate. When it comes to mortgages and interest rates, they’re determined by a number of factors, according to Forbes. These include:
- Credit scores
- Past financial issues (bankruptcy, foreclosure, etc.)
- Employment history
- Outstanding debts
- Cash on hand and assets
- Down payment
- Loan type
What is credit score?
A credit score is a three-digit measurement to determine the likelihood a person to pay back a loan over time, according to Equifax. When it comes to getting a home loan, the higher your credit score, the better.
There are different scoring models, so yours might vary slightly from company to company, but generally speaking, they’ll look at your complete credit history to see if you’ve been a dependable borrower. Do you use a large percentage of your available credit line on your cards? Do you make on-time payments toward your car loan? Do you have years of proof that you’re a reliable borrower? The answers to these questions can all shape your credit score. Credit score ranges vary depending on the scoring model, but Equifax’s are a good example to look at.
- Poor credit: 300-579
- Fair credit: 580-669
- Good credit: 670-739
- Very good credit: 740-799
- Excellent credit: 800-850
Taxes, homeowners insurance, and homeowners association (HOA) fees
You’re paying for more than four walls and a roof when you purchase a home. In addition to paying back your loan and interest, you’re responsible for paying taxes, any necessary insurance premiums, and fees.
Property tax is a number assessed by local government based on the value of your home and the land it resides on. Homeowners insurance protects your property from covered damages and you from liability for covered incidents that occur on your property. Property taxes and homeowners insurance are often lumped together into your monthly payment depending on the type of loan you have and how much you put down, according to Experian. HOA fees are paid separately. When you finish paying off your mortgage, you’ll be responsible for property taxes and homeowners coverage on your own if you aren’t already. It’s worth noting that all three of these expenses are subject to change, so your monthly payment could go up or down.
What types of housing loans are there?
Every individual or family has a unique financial situation, so there are plenty of housing loan options available. Here are five types of mortgage loans for homebuyers to consider, according to the Balance.
- Fixed-rate mortgages (FRM): If you enjoy budgeting and having consistent monthly payments, a fixed-rate mortgage could be for you. Your interest rate is locked in for the duration of your mortgage even if there is inflation or a recession. However, if interest rates are high when you purchase your dream home, you may be stuck with that rate unless you can refinance.
- Adjustable-rate mortgages (ARM): If you don’t mind a fluctuating interest rate and monthly payment amounts, an adjustable-rate mortgage could be an option for you. Adjustable-rate mortgages often have lower initial interest rates than fixed-rate mortgages, but they can move up and down to certain limits at different points in time as agreed upon in your loan.
- Conventional mortgages: This is the name given to mortgages that aren’t part of a special, government-backed program, making it the most common mortgage type.
- Government-backed mortgages: Certain government agencies, like the Federal Housing Administration (FHA) and the U.S. Department of Veteran Affairs, have special mortgage programs to help qualifying individuals get better deals or secure a mortgage when they couldn’t through traditional means. Read more on these special mortgage options below.
- Jumbo mortgages: This term is used to describe mortgages that are larger than the traditional limits. It is often used to finance expensive, extravagant properties.
The Balance notes mortgages typically fall under multiple of the above categories. For example, you can have a fixed-rate conventional mortgage or an adjustable-rate conventional mortgage.
What is an FHA Loan?
The Federal Housing Administration backs a unique mortgage option, called an FHA loan, that is available to individuals with lower credit scores and down payment amounts than many other loans, according to Bankrate. It can make it easier for younger individuals or first-time homebuyers to purchase a home. However, Bankrate notes there is a tradeoff because FHA loans mean borrowers are forced to pay FHA mortgage insurance to help protect the lender from defaults.
What is a VA Loan?
Eligible active duty, reserve and retired service members (and their spouses in certain cases) can take advantage of this special mortgage option. VA loans allow members of the armed forces to buy or build a home with no money down, quality interest rates and financing without a mandated cap, according to Military.com. VA loans are issued by private lenders, but they’re backed by the U.S. Department of Veteran Affairs, allowing low down payments and eliminating PMI in many cases. The VA’s commitment has reportedly helped make housing more affordable for more than 25 million military members since 1944.
Protect what might be the biggest investment you’ll ever make
Homeowners insurance could help cover everything from tornados, hurricanes, vandalism, lawsuits, theft of personal belongings at or away from home – and more. Your lender will likely require you to purchase home protection, but even when you’ve paid off your mortgage, it’s still worth keeping.