Last Updated on July 4, 2022 by Luke Feldbrugge
One of the first questions to ask yourself when starting your home buying journey is, how much house can I afford? Just because you get pre-approved for a loan doesn’t necessarily mean you can afford to make the monthly payments, and still do everything else you want. This is where budgeting, personal finances, staying on top of your credit, and other financial responsibilities come in to play. It also helps to have a home affordability calculator to determine how much you can afford to pay each month on a home mortgage and remain financially responsible.
While it might be tempting to simply use one of the many mortgage calculators you can find online, that alone doesn’t show the whole picture. Yes, those calculators can show you a quick estimate of how much your monthly mortgage payment will be depending on the size of the loan. But, they often fail to take into account different factors that are unique to you.
It is a good idea to dig into your total financial situation and consider the several types of loans that are available to you. 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 the worksheet to determine a good estimate for your current situation BEFORE speaking with a mortgage professional and getting pre-approved for a home loan.
Also, if you are a hero, meaning a teacher, healthcare professional, active or retired military, law enforcement, firefighter, or EMS professional, you qualify for our Hero Rewards. After pairing you with our local real estate specialist and/or mortgage specialist, these are savings are given directly back to you after closing. Our heroes save an average of $2,400 on their transactions. To find out more sign up today with no obligation.
How Much House Can I Afford | 28-36 Rule
When you start looking into how much house you can afford, you should start applying through a mortgage lender. Most banks and mortgage lenders want to know two main things:
- Your willingness to pay a loan (typically determined by your credit score)
- Your ability to pay the loan back
In order for you to answer these questions, you need to take into consideration several factors, like your salary, debts, credit score, and the actual costs of buying a home. Something to help put all these numbers into perspective is the 28-36 Rule. This general rule helps a bank and/or lender determine how much house 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.
How Does the 28-36 Rule Work?
Your Maximum Household Expenses (PITI) should not exceed 28% of your gross monthly income (before taking out taxes and deductions). 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%, 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. Using the same example salary as above, that would be $2,100. Most banks and mortgage lenders want this ratio to be 36% 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. Banks and lenders typically consider debt made up of the following:
- Car loans
- Education/Student loans
- Home equity loans (ex: second mortgage)
- Outstanding credit card balance
Types of Home Mortgage Loans
Once you have shown the mortgage company your debts and incomes, you need to decide which type of loan makes sense for you. This is where our real estate specialists and mortgage loan specialist can help answer any questions you have and be able to match you with the best mortgage you can afford that works for your long-term plans. Below are the most common types of home mortgage loans:
This is the most common mortgage loan, and usually requires a 10 percent down payment and good credit. Interest rates tend to be lower the better your credit. Many people believe you need a 20 percent down payment to qualify for a conventional loan. That’s actually not the case! It’s great if you can, because it will help you pay down the principle faster, but it’s not a requirement. If you can put 20 percent down, though, you won’t need to pay extra for private mortgage insurance (PMI). Conventional loan terms are in 30, 20, 15, and 10-year increments, meaning you have that many years to pay off your loan. The most common of these is the 30 and 15-year term loans. Generally, the longer the term, the higher the interest rate.
The majority of home buyers opt for 30-year 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. This is because there is less of a period of time to pay interest over. Rather than get locked into a 15-year mortgage, where you must pay it off in 15 years, you could also opt for a 30-year mortgage and make additional monthly payments when the money is available, like with yearly bonuses or tax refunds.
- 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 a good or excellent credit score. Interest rates will be higher, but qualifying for the loan is easier.
- VA Loan: Home purchases with a VA loan are for our military service men and women. VA-guaranteed loans are available for homes that are your primary residence. The good thing about VA loans is that they offer competitive interest rates and often do not require a down payment or private mortgage insurance (PMI).
- USDA Loan: The USDA loan is for people buying in rural areas, and some specific zones in the suburbs. USDA loans are also a zero-down payment loan, meaning you do not need to pay anything for a down payment. These loans are also better for people with lower credit scores.
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 rate you pay. Interest rates change daily. Check today’s interest rate here.
- Fixed Rate Mortgage: A fixed rate means your interest rate will not change throughout the life of the loan. 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, since those can fluctuate year over year.
- ARM (Adjustable-Rate-Mortgage): This loan typically has a lower interest rate for a fixed period of time, given to you at the start of the loan. Then, after the agreed on time, the rate can move up, or down, depending on a variety of factors like the economy. These can be beneficial because the interest rate is usually lower to start. However, when your fixed rate period is over, rates can sometimes skyrocket depending on market factors.
Other Mortgage Affordability Factors
- 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, pension, disability income, or social security. Most homebuyers can provide this information with their pay stubs and W2’s. When the time comes to speak with a lender, you’ll need to provide several years of tax returns as well. Each lender’s requirements can be slightly different, so make sure to talk to your lender and understand their requirements.
- 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, child care, health insurance, car maintenance and gas, personal care (gym membership, clothing), entertainment (dates, vacations). This will give banks and lenders an idea of how much income you have left to afford your home loan.
Four Other Costs to Buying a Home
Typically, your mortgage payment includes your principle and interest to pay. But, there are other costs to consider when determining how much mortgage you can afford. These are one-time costs, meaning you will not need to pay them monthly in your mortgage payment. Still, they are costs you should be aware of.
- Down Payment: A down payment is a portion of the total home sale price paid to the seller at closing. It does not need to be 20 percent, but if it isn’t, most lenders will require you have PMI. Typically, PMI can be rolled into your mortgage payment.
- 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 to your real estate specialist and lender 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.
Knowing How Much House I Can Afford
If you haven’t yet, take the time to fill out the Home Affordability Calculator Worksheet. Put yourself in a position to get the house you want without putting yourself in an uncomfortable position financially.
Get pre-approved for a mortgage loan with a qualified mortgage lender, like our mortgage specialist in your area. Pre-approval can also provide you an advantage when you find the right home. Home sellers consider pre-approval a good sign your loan will be approved and not cause issues with the purchase of their home and that gives you a competitive advantage.
Sign up today 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 an average of $2,400 after closing on their new home with our specialists.