When we’re on the verge of purchasing a new home, our eyes are sometimes bigger than our pocketbooks. We’re about to enter into a decades-long commitment, and we don’t want to be tied down to a house that’s anything short of perfect. But getting saddled with a mortgage we can’t handle is equally disastrous. This highlights the importance of a little financial planning. Thankfully, it’s easy to know how much house you can afford with our Mortgage Calculator.
Can I Afford A House?
Finally being called a ‘homeowner’ is rewarding, but buying a house comes with a lot of risks, especially if you bite off more than you can chew financially. That is why before searching properties and pre-qualifying for loans, you should calculate how much you can actually afford in monthly payments. We made this ‘How Much House Can I Afford?’ calculator to help you make financially sound decisions.
>> Also See: To Rent or To Buy A House?
The Main Factors: Income, Debts and Obligations, Downpayment
When calculating how much house you can afford to buy, lenders often consider three main factors – your household income, your current and prospective debts and obligations, and how much savings you have for a downpayment. Below is a breakdown of each of these.
- Household income: This is your and your spouse’s (if applicable) current combined income per year before taxes, which helps lenders decide if you have the ability to repay your mortgage. More than the total amount though, they look at your debt-to-income (DTI) ratio, which tells them how much of your income goes to paying debts and obligations.
- Debts and obligations: On that note, lenders also look at your other debts and obligations to calculate your DTI. Typically, these are your auto loan and credit card payments, your property taxes, your student loans, even child support payments if applicable.
- Down payment: Most lenders require at least a 3% down payment, but the higher you put down, the less you’ll have to pay monthly and the more likely you’ll be approved. While some lenders don’t require a down payment, putting one down shows them you’re committed to buying the property and repaying your mortgage.
Those are the main factors lenders look at when assessing home buyers, but there’s more to consider when buying a house.
>> Learn More: Home Down Payment Calculator
The Dangers of Buying a Home You Can’t Afford
Despite the factors lenders check, ultimately, it is you who can tell how much house you can afford. And besides, you’re also the one who’s taking the risk. So before we get into the nitty-gritty of deciding how much you can afford to buy, let’s take a quick reality check and look at what could happen if you get in over your head financially.
Many folks find themselves stressed about finances and making their mortgage payments; some have to pick up extra work on the side to make ends meet. The worst case scenario is that you’ll lose the house to foreclosure. The lender will take possession of it and sell it at an auction to recover what they lost. You will be entitled to excess proceeds from the sale, so you could still recover some of your losses, but keep in mind that foreclosed properties rarely sell at market price.
Now, there are ways to avoid foreclosure. For example, you can refinance your loan to lower your monthly payments, but doing so will extend your loan term or result in higher interest. Another option is to borrow from your retirement funds, but that’s not the wisest move financially, either.
The wisest move is to buy within your means in the first place, and so, here’s a good rule of thumb to follow when deciding how much house to buy.
The “28/36 Rule”: A Good Rule of Thumb
When it comes to deciding how much house you can afford to buy, lenders typically follow the “28/36 rule.” It’s also a good guideline to follow when looking at your own finances.
The “28/36 rule” is based on your DTI. It states that you shouldn’t spend more than 28% of your gross income (income before taxes) on housing costs including the principal, interest, taxes, and insurance (acronymed PITI). Additionally, all your debt combined, including housing costs, should be within 36% of your gross income.
For example, if your gross monthly income is $5,000, your total PITI costs shouldn’t exceed $1,400 per month and all your debts and obligations combined shouldn’t be more than $1,800.
Use our “How Much House I Can Afford” calculator to conveniently compute your DTI, how much loan you can take out for a house, your ideal loan term, and your estimated housing cost.