How much house you can afford is directly related to the size and type of mortgage you can qualify for. Understanding how much you can comfortably spend on a new mortgage while still meeting your existing obligations is crucial during the homebuying process.
Read on to learn about home affordability, and use our home affordability calculator to find out if you can afford the house of your dreams.
How Much House Can I Afford?
Purchasing a home is a decision that will impact your financial situation for the next 15 to 30 years. It’s important to be realistic about your monthly income and expected expenses to avoid winding up with a mortgage loan you can’t pay in the long run. We recommend visiting our best mortgage lenders page to find the most affordable home loans.
How much house you can afford will mainly depend on the following:
- Your loan amount and mortgage term
- Your gross monthly and annual income
- Your total monthly debt or monthly expenses, including credit card debt, student loan payments, car payment, child support, and other expenses
- State property taxes, which are paid annually or biannually and vary by state
- Current mortgage rates and closing costs, both vary by location
- Homeowner’s association (HOA) and condo fees
In this guide, we cover:
- What Is the 28/36 Rule?
- How Do You Calculate Your Home Affordability?
- House Affordability Options
- Home Affordability and the Covid-19 Pandemic
What Is the 28/36 Rule?
Lenders may determine your ability to afford a new home by using the 28/36 rule. Breaking it down, the rule establishes that:
Housing expenses should be no more than 28% of your total pre-tax income. This includes your monthly principal and mortgage interest rate, annual property taxes, and private mortgage insurance payments (PMI).
Total debt should not exceed 36% of your total pre-tax income. This includes the housing expenses mentioned above — credit cards, car loans, personal loans, and student loans — so long as these monthly debt payments are expected to continue for 10 months or more.
In concrete numbers, the 28/36 rule means that a borrower who makes $5,000 a month should not spend more than $1,400 on housing costs every month. If you’re a renter, that’s the most you should spend on your lease to maintain good financial health.
However, for a homeowner, $1,400 should cover your monthly mortgage payment, as well as homeowners insurance premiums and property taxes.
How Do You Calculate Your Home Affordability?
There are several methods for figuring out your home affordability. The easiest way is to enter your information into our calculator above. Our home affordability calculator works with either your debt-to-income ratio or your proposed housing budget.
For the first method, you’ll need your gross monthly income and monthly debts; for the second, you’ll need your desired monthly payment amount. Both methods will require your down payment amount, state, credit rating, and home loan type.
Once you’ve input all the information according to the method you chose, our calculator will let you know the top amount you can pay for a house, as well as your estimated monthly payment.
Your credit score is a three-digit summary of your creditworthiness. A very high credit score usually corresponds to a lower interest rate, whereas having a low score will result in much higher rates.
The credit score is one of the most important factors that lenders consider when applying for a mortgage. Lenders use it to determine how likely they’ll be repaid on time if they give a person a loan.
Homebuyers have access to a free credit report once per year from each of the three major credit bureaus. You may also access your credit report for free under certain conditions, like being the victim of identity theft.
Debt-to-Income Ratio, or DTI, compares how much you owe to how much you earn, specifically your monthly debt compared to your monthly pre-tax household income. It’s an important metric that lenders use to determine how much you can borrow — or if you can borrow at all.
A high DTI indicates that your debt is high relative to your income and vice versa. The higher your DTI, the harder it will be to get a mortgage. In fact, many lenders won’t even consider applicants with a DTI higher than 43 percent. Lenders prefer borrowers with a DTI of 36 percent or less and will offer them better interest rates on their mortgage. To calculate your DTI, use our debt-to-income ratio calculator.
Unless buyers are applying for a VA loan or a 0% down payment mortgage program, they will have to provide a down payment on their home. Conventional loans have a minimum down payment of 3 percent for certain buyers and 5 percent for most buyers. For FHA loans, the minimum is 3.5 percent.
Ideally, buyers should be able to provide a 20% down payment on their homes. A payment this large will:
- Lower your loan-to-value ratio
- Lower your monthly payments
- Make it more likely to earn a lower interest rate
- Buy you enough home equity to bypass private mortgage insurance
If you don’t have enough money for a down payment this large, there is the option of refinancing later on. This can get you a better rate if the market conditions are favorable.
To find out what your future mortgage rate would be after refinancing, use our mortgage refinance calculator. If you want to learn more about refinancing, check our best mortgage refinance lenders page for more information.
House Affordability Options
There are several options to consider if you are struggling to afford the home you have your eyes on. Some methods must be undertaken over time, whereas others will immediately impact your mortgage application.
DTI is one of the most important factors that lenders consider when looking at borrowers. Lowering your DTI by paying off as much existing debt as possible will put you in a better position to manage your monthly costs and any emergency expenses that may spring up. This is a good option if your DTI is too high to get pre-qualified for a reasonable interest rate (or to qualify at all).
Higher credit score
As with any other big purchase, the better your credit score, the lower your interest rate. One way to improve your score is to make your credit card payments on time every month. Another is to reduce your debt — which will also lower your DTI ratio.
The type of mortgage you’re requesting will help determine a lender’s flexibility in evaluating your loan application. FHA loans, VA loans, and USDA loans all have certain benefits that may help you afford the home you want.
FHA loans are insured by the Federal Housing Administration and have more relaxed qualifying standards. They feature maximum qualifying ratios of 31/43 for most applicants with a credit score higher than 500 — 31% for housing costs and 43% for total debt. This makes them ideal for first-time home buyers.
You may be allowed to have ratios as high as 40/50 with this type of loan if your credit score is over 580 and you meet other requirements.
Borrowers with a military connection may qualify for a VA loan. VA loans are more lenient than conventional and FHA loans. They are backed by the Department of Veterans Affairs and typically don’t require a down payment.
While the maximum DTI ratio is set at 41% in the general guidelines, the VA insures loans for people with higher ratios provided they meet other compensating factors.
If you’d like to explore VA loans further, visit our best VA loans page.
USDA loans are backed by the U.S. Department of Agriculture and offer many benefits over conventional loans. They enjoy lower interest rates, are more lenient with credit scores, and offer 100% financing, meaning you do not need to provide a down payment.
The catch is that USDA loans are designed to help finance homes only in eligible rural areas. The desired property must fall within specific geographical areas, generally outside the limits of major metropolitan centers.
If you are eligible, USDA loans have many benefits, and you may build, rehabilitate, improve or relocate a dwelling as your primary residence to your new location.
Higher down payment
Most applicants will need to put at least 20% down on their mortgage if they want to avoid paying for private mortgage insurance. While there are options if you don’t have that much money upfront, increasing your down payment could reduce your interest rate, monthly payment, and DTI ratio considerably.
Home Affordability and the COVID-19 Pandemic
The coronavirus pandemic and the resulting economic downturn have shaken up the real estate market. In August, the median home price in the U.S. rose to $290,225 — an annualized 15.9 percent from the prior month. Mortgage rates remain near historic lows as of September, but there is no way to know whether they will fall even lower or start to move back up.
The fact remains that interest rates are lower right now than they have ever been. If you are in a good financial position to purchase a home at the moment— meaning you have enough cash for a down payment, a good or great credit score, stable employment, and a low debt-to-income ratio — it may make sense for you to take that step now rather than later.