If you’re considering buying a home, you might be asking yourself “How much house can I afford?”
This is an important question, And I can tell you that if you’ve got good credit, your loan officer will probably give you a target purchase price number that’s higher than you expect.
However, mortgage company views on what an affordable house is can be much more lenient than what is truly best for your budget.
In this article, we’ll show you how to calculate what you can truly afford to spend on a house.
In This Article
- Calculating How Much House You Can Afford
- House Buying Considerations
- How To Avoid Becoming House Poor
Calculating How Much House You Can Afford
Whether you’re buying your first home or leveling up, the last thing you want is to be strapped for cash after you move into your new home.
Homeownership comes with a lot of little extra expenses that you as a renter may not have had to worry about.
There are repair bills, maintenance bills and home improvement costs. There are annual property taxes, homeowner insurance costs and more.
We’ll share tips here on how you can be prepared for some of life’s “pop-up” expenses in a way that doesn’t hinder making your house affordable.
We’ll also share guidelines as to how to determine a comfortable house payment.
And we’ll show you a calculator designed to assist you as you decide how much to spend on your new home.
Knowing the information that can help you choose a comfortable home purchase price will help make the home-buying (and home owning) process smoother.
Here are some tips for calculating a comfortable mortgage payment for your new house.
Multiply Your Annual Income by 2.5 or 3
Some experts recommend using a simple rule of multiplying your gross income by 2.5 or 3 in order to get to a comfortable purchase price for your home.
For instance, let’s say your household income was $100,000.
- 100,000 x 2.5 = $250,000
- $100,000 x 3 = $300,000
In that case, you’d choose a house with a maximum purchase price of either $250,000 or $300,000.
If your household income was at $75,000, you’d choose a house with a maximum purchase price of either $187,500 or $225,000.
Using that rule means that you could probably get away with a 15-year mortgage loan term as opposed to a 30-year mortgage loan.
And even if you chose to do a 30-year loan, you would probably have sufficient surplus cash each month to make extra payments on your mortgage.
Of course, that would depend on how the rest of your monthly budget looks too.
The 36% Rule
The 36% rule is a rule that mortgage lenders often use in regards to determining how much house you can afford.
When mortgage lenders refer to 36% they’re talking about the percentage of you and/or your partner’s total gross income that should make up all debt payments.
This is called a back-end debt-to-income ratio.
As an example, let’s say that you and your partner had a total income of $150,000, or $12,500 per month, gross.
The lender would prefer that your total mortgage payment including PITI (principal, interest, taxes, and insurance) along with all of your other credit obligations would total a maximum of $4,500 per month.
While many would agree this is a safe rule to use when buying a house, it’s important to remember one hidden caveat.
Lenders will often go up to 45% or even 55% for a back-end debt-to-income ratio for mortgage loans, especially if you have good credit.
For that reason, it’s up to you to be your own personal finance advocate and tell your lender that you’d like to cap your back-end ratio at 36%.
The 28% Front-End Ratio
There’s another number that lenders use called a front-end debt-to-income ratio.
This number is simply the percentage of your gross income that your PITI mortgage payment takes up.
As an example, let’s say your gross income is $5,000 per month. In that case a lender would approve your total PITI mortgage payment as $1,400 per month.
Your back-end debt-to-income ratio (using the 36% rule) would then be calculated as $1,800 per month.
If you purchased a home using these ratios, that would leave $400 extra each month to cover car payments, installment loan payments, and any credit card payments.
Your job when using these types of front-end and back-end debt-to-income ratios to calculate how much house you can afford is to make sure you can live within them.
Also, keep in mind that just as with back-end ratios, lenders are often willing to go above a 28% front-end ratio for borrowers with good credit.
Again, it’s important to be your own advocate and set your own rules, regardless of the mortgage amount your lender will approve you for.
The Dave Ramsey Mortgage
Personal finance expert Dave Ramsey has his own rules for determining how much house you can afford.
And some might claim that Ramsey’s rules are much too conservative.
However, there’s no arguing that following his suggestions will help you go the extra mile when it comes to financial security.
Here’s a list of Dave’s preferred guidelines that you should follow when you’re determining how much house you can afford.
- You’ve saved a minimum down payment of 10%, preferably 20%
- You have zero other loan or credit card debt
- Your emergency fund is fully stocked at 3-6 months’ worth of expenses
- You qualify for a 15-year mortgage on the house you want to purchase
Dave Ramsey is often touted as an extremist when it comes to his personal finance rules.
But I think we can all agree–especially those of us who have learned the hard way–that it’s better to be safe than sorry when it comes to how secure of a financial picture you want to create for yourself.
And that motto applies to determining how much house you can afford as well.
Use An Online Calculator
This online calculator will help you determine how much house you can afford. Note that the calculations here are simply an example.
Only you can truly determine how much house you can afford.
We’ve set the calculator up so that it chooses a home amount based on certain DTI parameters. The calculator will help you stay within a 28% front-end ratio and a 36% back-end ratio.
These parameters are lower than what you’ll find at most lenders, however, they’ll help ensure you avoid overborrowing.
What did the numbers show? Did the calculator show that you could afford more house than you thought you could or less?
While only you can determine what is a comfortable house payment for you, getting other opinions can be helpful.
Just be sure to choose a home that will allow you to have enough financial flexibility to live your life.
House Buying Considerations
The next step in determining how much house you can afford is to look at your personal considerations. There are several things to consider as you do that.
Needs Vs. Wants
It’s easy to get caught up in competing with the Joneses when you start house shopping.
This is especially true as you look at houses in increasing price ranges. However, keeping needs vs. wants in mind can help.
You might really want that house with the built-in pool and the indoor sauna, but do you need those things?
Geographical location is a consideration too. For instance, if you’re buying in Phoenix, a pool is much more of a necessity than it would be if you were buying in Minneapolis.
Be certain as you shop for a home that you’re very clear on what your individual needs are for a home vs. what your wants are.
In fact, you may want to make a list for your needs and a separate list for your wants.
Be sure you’re working to check off all of the boxes as you consider your needs when you look at homes.
And if the home that covers all of your needs happens to have some of your wants too, that’s simply icing on the cake.
What is Your Current Financial Situation?
It can also be a good idea before buying a home to get a clear picture of your current financial state.
Use a spreadsheet or piece of paper to write down your current financial numbers.
Make a list of all of your assets, liabilities and current monthly expenses. Create a monthly budget of your current expenses if you don’t already have one.
Don’t forget to include those little extra expenses such as entertainment expenses and miscellaneous spending.
Assess your savings account and the equity in your current home if you own it. Determine how much money you have to put down on your new home purchase.
Knowing exactly where you stand financially will help you use wisdom as you make your purchase decision.
Know The Type Of Home You Want
Now that you know exactly where you stand financially you’ll want to consider another question. That question is “What kind of house do I really want?”
Yes, it’s tempting to buy the biggest and best house you can possibly afford. After all, the home we own is a symbol of our success, isn’t it?
Or is it? I noticed something interesting after 15 years of working in consumer banking and mortgage.
Working in banking taught me that the wealthiest people didn’t always have the best houses. Conversely, I also learned that people with the best houses weren’t always wealthy.
The take away here is that while a house may appear to be a symbol of your success, it can also be a huge burden if you buy more than you can afford.
So, when considering how much house you can afford, you need to consider other factors as well.
Factors such as:
- Am I prepared to repair and maintain a bigger, more expensive house?
- Do I want to clean a huge house?
- How much of my income to I want to spend on housing each month?
- How many years do I want to be tied to my job in order to have this house?
The type of house you choose will have an impact on many other areas of your life. It will determine how much discretionary income you have left over at the end of each month.
It will dictate how much of your time is used to pay for the house and maintain it.
Although it might seem tempting to buy the biggest house you can afford, it’s important to think long-term.
You may not need a 3,500 square foot house for you, your spouse and your two kids.
And if buying one that size will take all of your weekends to clean and maintain, you may want to consider something cheaper.
Cheaper Isn’t Always Better
Conversely, you don’t want to buy something that’s too inexpensive or small for your needs. Don’t buy a fixer-upper if you don’t want to spend every weekend working on it.
Think twice about buying a 1,000 square foot house that will have the kids tripping over each other.
Don’t buy a two-bedroom house if you have two kids and plan on adding two more soon. Buy a home that will fit you for as long as you plan on living there.
And buy a home you’ll be happy staying in if you have to.
Be wary of buying something that you don’t like or is too big or small. And buy something you can love even if it’s not perfect.
Too many people sacrifice important home characteristics with the thought that they will simply move if they want to.
You may plan on moving in five years, but things have a way of changing. If you can’t stand the idea of being stuck in a house forever, you may want to keep looking.
Especially if there are things about the home or neighborhood that drive you crazy.
Every person and family has different personal and group needs. Your income, your need for personal space, the time you spend in your home; it all matters.
And it should all come into factor as you determine what type of home you want to buy.
My advice? Shop a LOT. Look at several different types of houses and sizes of houses before making a purchase decision.
If you don’t want to do outside maintenance, consider a townhome or condo. Or, consider hiring out each week for lawn service.
Buy the right amount of house for your needs – both long and short term.
Consider Your Other Financial Goals
Your other financial goals may not seem as if they have a bearing on your home purchase, but they do.
The amount of money you spend on your home will have a direct impact on your other financial goals.
Every dime you spend on the house you buy is a dime you can’t spend on your other goals. This is a major reason why price consideration is so important.
If a primary goal for you is travel, you’ll want to make sure your house payment doesn’t hinder that goal. If you want to reach financial independence soon, the same goes.
It may be helpful to figure out your other financial goals before you decide how much house you can afford.
That way you can determine how much of your income you need to funnel toward those other goals.
The leftover money each month can then be used to decide how much you want to spend on housing.
We often don’t think about other financial goals in relation to our housing purchase. It’s not until we see our mortgage payment hindering other purchases that it becomes clear.
You read a book on financial independence and it shows you how you can get there in 10 years.
However, your massive house payment means you don’t have the extra money to save.
Or you want to save to pay for your kid’s college but you just don’t have the extra money.
Being house poor means your house payment is so big that there’s nothing left over to pay for extras.
Whether that’s saving for college, for retirement or just having money to go out to eat, it all matters.
Your mortgage payment should be small enough that your discretionary income allows you to live as you wish.
Related Article: 7 Ways to Pay off Your Mortgage Faster
Your House Shouldn’t Be Your Only Financial Goal
It’s also important to consider your other expenses and your other financial goals.
Just because the “system” says you can afford a payment doesn’t mean that payment won’t hinder your lifestyle.
Although your loan officer likely has the best of intentions in helping you, the system’s goal is to make money.
When I was in the mortgage business, we were constantly trained to “help” clients by approving them for larger loans.
We were told over and over how it was our “job” to help them achieve their homeownership dreams.
The bigger the loan we could get them approved for, the more we were “helping” them reach their dreams.
As a loan assistant, it felt good to be praised for being such a big “help” to clients.
But looking back and living through the housing market crash, I see things much differently now.
Five years of working directly with people on how to gain control over their finances have taught me differently.
It’s taught me that financial security is much more helpful than having your dream house.
So be your own advocate when determining how big of a payment you can truly live with.
Take your loan officer’s words into consideration but be sure you are the one who ultimately determines what you can afford.
Related Article: Best Mortgage Lenders to Buy a Home
How To Avoid Becoming House Poor
And if you don’t be cautious as you make that determination, you could end up being house poor.
As far as numbers go, “house poor” is often defined as having a mortgage payment exceeding 40% of your gross income.
I talk about that more in this article on how to avoid becoming house poor.
Simply put, house poor means that you have too big of a house payment for your income.
It means your mortgage payment is so large that you have little left over in your budget for other things.
How can you avoid having your house put you into a situation where you are or feel house poor? Here are some recommendations.
Put at Least Twenty Percent Down
Although a large down payment on its own won’t help you avoid being house poor, it will save you money.
Conventional loans with less than 20% down are required to carry private mortgage insurance.
Private mortgage insurance can cost upwards of a couple of hundred dollars a month depending on your initial mortgage amount.
If you put 20% down and avoid having to carry mortgage insurance, that’s one less expense to worry about.
That “one less expense” will add up over the long term and help make getting through income fluctuations easier too.
Keep Your Front-End Ratio at Twenty-Eight Percent or Lower
As I mentioned above, sticking to a front-end/back-end debt-to-income ratio of 28/36 is a wise move.
And as Dave Ramsey says, keeping your mortgage payment under 25% of your gross income is even better.
The less of your income your mortgage payment takes up, the less of a burden your home will be. Keep that in mind as you shop for homes.
Create a Home Repair Fund
Another way to avoid becoming house poor is to start a separate savings account for future house-related expenses.
We all know that furnaces, windows, and appliances will need to be replaced eventually.
The problem is that you never know when those items will begin to fail. It could be next month or it could be in five years. Either way, you don’t want to be caught unprepared.
One way to prepare for those types of expenses is to modify your budget to include money for home emergencies.
Add a line item in your monthly budget for your “home repair fund”. Put some cash in that fund each and every month.
Store the money in a high-yield savings account.
As the home repair account grows, you’ll become more prepared to pay cash to replace items such as windows.
If an appliance goes out or if the roof needs replacing, you’ll have the expense covered.
Then you can avoid the shock of being presented with a large bill and not having cash to pay it.
You’ll simply pull the money out of your home repair fund and go on your way.
Have an Emergency Fund
Another way to avoid having your house payment hinder your money is to have a fully stocked emergency fund.
While your home repair fund will specifically cover replacing items for the home, an emergency fund is different.
An emergency fund will help you pay your bills should you become unemployed.
You may go through a period where your income is down because you get laid off from your job. Or if you can’t work due to a physical or other disability.
Similarly, maybe you just need to take some time off to de-stress. Or you are forced to take a lower paying job.
These types of drops in income could make your house payment a burden.
Having an emergency fund would help you make house payments (or some of your house payment) during this “no income” or “lower income” time period.
The money in an emergency fund is used specifically as income replacement during a job loss. How much cash should you have in your emergency fund?
We suggest a minimum of three months of living expenses, preferably six to twelve months of living expenses.
Keeping at least three months’ worth of expenses in your emergency fund will give you a solid financial cushion until you find replacement income.
Think Twice About Choosing a Variable Loan Rate
Variable mortgage loan rates can be attractive to prospective homeowners because they’re generally lower than fixed rates.
However, unexpected rate increases – and the resulting higher mortgage payments that come with them – can be burdensome to homeowners.
A variable/adjustable-rate mortgage can be a good deal if you don’t plan on owning the house for long.
But if you think you’ll own the house for longer than 3 to 5 years, a fixed rate is probably best.
Variable rates do have the potential to go down depending on how the economy is performing. However, they also carry the potential to go up.
And if that’s the case, the resulting higher house payment may put a burden on your budget.
Choosing a fixed rate mortgage will provide you with a stable house payment you can count on for years to come.
Of course, tax and insurance amounts can change, but the basic principal and interest payment will remain steady.
Homeownership comes with many great benefits. It allows you to have something of your own and design it as you wish.
There can also be financial benefits such as mortgage interest deductions and equity buildup.
Many people have increased their net worth considerably through homeownership. The key is in buying wisely.
Choose a house that will allow for comfortable payments – even through periods of extensive repairs that may be needed.
Be sure your mortgage payment amount allows you to travel, play and do the other things you love to do.
Part of what makes homeownership fun is being able to still afford to live life outside of your home.
Are you a homeowner, or considering becoming one? If so, what steps are you taking – or did you take – to buy affordably? Share in the comments below.