Making the decision to become a first time home buyer is complex. Or, if you’re looking to purchase your next house, sometimes it’s hard to know where to start. A good first step is answering the question: How much house can I afford?
While it might be tempting to simply use one of the many mortgage calculators you can find online, which will determine how much your monthly mortgage payment will be depending on the size of the loan, that alone doesn’t show the whole picture. It is a good idea to dig into your total financial situation and consider several types of loans that are available to you.
The 28-36 Rule is a Good Thing to Know
Most banks and mortgage lenders want to know two things:
- Your willingness to pay a loan (typically determined by your credit score)
- Your ability to pay the loan back
One thing they rely on for general guidance is the 28-36 rule to determine what a potential homebuyer like you can afford, and what they are willing to lend you. Even if your credit is impeccable, you will still need to prove you make enough money to pay your monthly payments.
The 28-36 rule states the following:
Your Maximum Household Expenses (PITI) should not exceed 28 percent of your gross monthly income (before taxes and deductions are taken out). For example if you make $70,000 a year and divide it by 12 months, your monthly gross income is $5,833. Multiply that by 28 percent, and your monthly PITI should be less than $1,633. Here is what makes up your PITI:
– PRINCIPAL: The part of a mortgage payment that pays down the amount borrowed
– INTEREST: Percent rate charged by creditors for lending you the principal
– TAXES: This is your property tax
– INSURANCE: This is your homeowners insurance (and if necessary, your private mortgage insurance, or PMI)
Your Total Debt or Debt-to-Income Ratio (DTI) should not exceed 36 percent of your gross monthly income. Your debt determines, in part, how much of a mortgage loan you can afford. Lenders calculate your debt-to-income by dividing your monthly debt by your gross monthly income. Most banks and mortgage lenders want this ratio to be 36 percent or lower. That’s why it’s a good idea to pay down your debt before applying for a loan. This is a general guideline lenders consider. It’s not a requirement to receive a mortgage. “Debt” is commonly made up of the following:
– Car loans
– Education/Student loans
– Home equity loans (ex: second mortgage)
– Outstanding credit card balance
Recommended Tool: Home Affordability Calculator Worksheet
To better answer the question, “How much house can I afford?” we recommend using our Home Affordability Calculator Worksheet. Homes for Heroes likes to make sure our heroes are set up for long-term financial success, so we recommend you fill out our Home Affordability Calculator worksheet to determine a good estimate for your current situation.
Types of Home Mortgage Loans
Conventional Loans: This is the most common mortgage loan, and usually requires 10 percent down and good credit. Interest rates tend to be lower the better your credit. If you can put 20 percent down, you won’t need to pay private mortgage insurance (PMI).
Fact Check: Many people believe you need a 20% downpayment to qualify for a conventional loan. That’s not the case. It’s great if you can, but it’s not a requirement.
FHA Loan: Available to all types of home buyers, an FHA loan requires a smaller down payment, usually 3.5 percent, and doesn’t require stellar credits. Interest rates will be higher, but qualifying for the loan is easier.
VA Loan: Home purchase VA loans are for our military service men and women of the U.S. armed forces. VA-guaranteed loans are available for your occupancy or a spouse and/or dependent (for active duty service members). The good thing about VA loan is they offer competitive interest rates and often times without requiring a downpayment or private mortgage insurance (PMI).
USDA Loan: This type of loan is for people buying in rural areas, and it is also a zero-down payment loan.
Loan Term Mortgage Options
The majority of home buyers opt for 30-year fixed home loans. Opting for a shorter term, like a 15-year fixed mortgage, will result in higher monthly mortgage payments, but in the long run will cost you less to buy the home.
Helpful Tip: Rather than get locked into a 15-year mortgage, where you must pay it off in 15 years, get a 30-year mortgage and make additional monthly payments when the money is available.
Interest Rate: Fixed vs Adjustable
After choosing the type of loan, you will need to decide if you want a fixed or an adjustable rate on the loan. This will determine the interest you pay.
Fixed Rate Mortgage: A fixed rate means your interest rate is “fixed”, and will not change. You will always know the amount of your monthly mortgage payment. However, it’s good to know if you roll other fees into your fixed mortgage, like property taxes or homeowners’ association fees, your mortgage payments may fluctuate over time.
ARM (Adjustable-Rate-Mortgage): This loan’s rate moves up and down over time. After the initial term ends, your interest rate and your monthly mortgage payment, increase or decreases annually.
Other factors to consider when asking yourself, “How much house can I afford?”
Income: You’ll need documentation of your earned wages and any other income you receive from employment, self-employment, bonuses, commissions, tips, alimony, child support, social security, pension, or disability income. When the time comes to speak with a lender, you’ll need to provide several years of tax returns as well.
Debt: This includes student loans, credit card balances, car loans, medical bills, debt consolidation, personal loans, and other outstanding debt you are paying off.
Other Expenses: Food (groceries, eating out), child-related expenses (daycare, activities, gifts), healthcare (monthly premiums, prescriptions, doctor visits), car maintenance and gas, personal care (gym membership, haircuts, clothing), pet care (vet, grooming, food, toys), entertainment (dates, movies, vacation), donations and gifts.
There are Four Other Costs to Buying a Home
These are the primary costs you will be responsible for before the home is yours, and you get to put your feet up and soak it all in. By working with Homes for Heroes specialists you can save on some of these costs, but for planning purposes, it’s good to know about the four other costs of buying a house.
Down Payment: A down payment is a portion of the total home sale price paid to the seller at closing.
Earnest Money Deposit: An earnest money deposit is a good faith deposit to the seller. It helps to show the seller you’re committed to buying the home.
Closing Costs: Closing costs are fees associated with the purchase of your new home and are paid at the closing of your real estate transaction.
Moving Costs: Moving costs can add up whether you are moving thousand of miles away or two blocks down the road.
The Best Answer to “How Much House can I Afford?”
Get Pre-Approved: Now that you know the basics, put yourself in a position to get the house you want. Get pre-approved for a mortgage loan with a qualified mortgage lender, like our mortgage specialist in your area. A loan pre-approval will give you a much more accurate estimate of how much you can borrow, and how much home you can afford.
Sign up and speak with our real estate and mortgage specialists in your area to learn more about how they can help you through the home buying and mortgage selection process to maximize your hero savings. Our heroes save, on average, more than $2,400 if they use our local specialists to purchase their home. There’s no obligation, and we guarantee the most hero savings among all national programs.
Want to do a deeper dive into this issue? Here are some additional resources for you to explore:
VA Loan Benefits