UPDATED: AUGUST 07, 2023 | 2 MIN READ
Homeownership is a significant milestone and a crucial financial decision that many individuals aspire to achieve. However, asking yourself, “How much home can I afford?” is only the first step in home-buying. When you understand the various factors that contribute to home affordability, it’s easy to make an informed decision on purchasing a home that fits your financial capabilities and long-term goals.
Mortgage calculator
A mortgage calculator is a tool used to calculate the monthly payments and total cost of a mortgage loan. To use a mortgage calculator, you need to input information such as the loan amount, interest rate, loan term, and down payment.
Once you have entered these details, the calculator will generate an estimate of your monthly payments and the total cost of the loan. You can adjust the variables to see how different scenarios affect your payments.
Using a mortgage calculator can help you determine how much house you can afford and make an informed decision about the type of mortgage that’s right for you.
Factors that help answer “How much house can I afford?”
Several key factors help you determine how much you can spend on a house, including your income, credit score, and debt-to-income ratio.
Income
Your income is one of the main factors in determining how much home you can afford. But what many people need to realize is this includes more than your salary.
When calculating your income, include your annual salary and any other money you receive regularly, such as dividend payments or income from a side business. This helps establish a baseline by telling the mortgage company what you can pay monthly.
Down payment
In 2021, the average down payment percentage for first-time homebuyers was around 7%, according to the National Association of Realtors. Repeat buyers put an average of 13% down when buying a house.
Your down payment depends on what you can afford and the type of mortgage you get.
Down Payment Example
| Type of Loan | Minimum Down Payment Required | Is Mortgage Insurance Required? |
|---|---|---|
| FHA Loan | 3.5% | Yes, for the first 11 years of the loan |
| Conventional Loan | 3% | Yes, if down payment is less than 20% |
| VA Loan | None | No |
| USDA Loan | None | No |
For example, you can put down as little as 3% if you qualify for a conventional home loan. However, mortgage insurance is added to your costs if you have a down payment of less than 20%.
But if you qualify for an FHA loan, you can have a down payment as low as 3.5% without the added fees because these types of mortgages are government-backed.
Active duty military members, veterans, and their families might qualify for a VA loan that doesn’t require a down payment. USDA loans are also available to specific rural areas and don’t require a down payment.
Determining your down payment
Remember, when determining your down payment amount, you want to maintain your cash reserves and consider having a down payment higher than the minimum required amount. After all, the higher your down payment, the lower your monthly mortgage payments.
Also, lenders tend to view mortgages with at least 20% down as more secure. When you put have at least a 20% down payment, you typically qualify for a lower interest rate.
Credit score
Your credit score is essential for determining home affordability, as it influences mortgage approval, interest rates, loan terms, and borrowing capacity.
Mortgage approval
The higher your credit score, the more likely you are to be approved for a mortgage because lenders view you as less of a risk. If you have a lower credit score, the mortgage company could decline approval or give you limited loan options.
Mortgage interest rates
People with higher credit scores also get lower interest rates because they’re less likely to default on the loan. This creates lower monthly payments, making the home more affordable in the long run.
If you have a lower credit score, your interest rate will be higher, but sometimes it’s possible to buy points to lower the percentage.
You could also save money to make your monthly payments more affordable. Remember, you can also refinance when your credit score is higher, so having a lower score shouldn’t keep you from buying a house.
Loan terms and conditions
A good credit score may give borrowers more favorable loan terms and conditions, such as lower down payment requirements or reduced mortgage insurance premiums. These factors can influence the overall cost of the home and its affordability.
Borrowing capacity
A higher credit score can also increase the amount you’re eligible to borrow, giving you more options regarding home prices and locations. This allows you to choose a home that aligns with your financial goals and needs.
Debt-to-income ratio
Your debt-to-income (DTI) ratio represents the percentage of monthly income that goes toward paying debts. Your debt-to-income ratio should be 43% or lower – 41% if you’re getting a VA or USDA mortgage. Keep in mind these percentages aren’t set in stone. Some lenders allow up to a 50% DTI ratio for conventional loans.
How to calculate your DTI ratio:
Follow these steps to learn how to calculate your debit to income ratio:
- Add all your recurring monthly debt obligations
Add all your recurring monthly debt obligations, such as credit card payments, student loans, car loans, personal loans, and any other monthly debt payments. Don’t include expenses like groceries, utilities, or insurance premiums, as these are not considered debt payments.
- Determine your gross monthly income.
This is your total income before taxes and other deductions. Include your salary, bonuses, commissions, tips, rental income, or any other regular sources of income.
- Divide debt by gross income
Divide your total monthly debt payments by your gross monthly income to get a decimal number representing your DTI ratio.
- Convert your DTI ratio to a percentage
Multiply the decimal number by 100 to convert your DTI ratio to a percentage.
For example, assume you have the following monthly debt payments and income:
- Credit card payment: $200
- Car loan payment: $300
- Student loan payment: $400
Your total monthly debt payments are $900 ($200 + $300 + $400).
And your gross income is $5,000.
To calculate your DTI ratio, you would divide $900 by $5,000 to get 0.18. Then, you multiply 0.18 by 100 to get 18. In this scenario, your DTI ratio is 18%.
Mortgage rates
Mortgage rates impact the overall cost of a home and its affordability. Buyers should monitor mortgage rates, as even a slight change can significantly impact a home’s monthly mortgage payment and long-term affordability.
In 2022, the average 30-year fixed mortgage rate was 5.34%, which was almost double the average interest rate in 2021. Even so, 2022’s interest rates aren’t the highest. For some perspective, here are the average interest rates on 30-year, fixed-rate mortgages over the past 22 years, according to Freddie Mac.
| Year | Average 30-Year Rate | Year | Average 30-Year Rate |
|---|---|---|---|
| 2000 | 8.05% | 2012 | 3.66% |
| 2001 | 6.97% | 2013 | 3.98% |
| 2002 | 6.54% | 2014 | 4.17% |
| 2003 | 5.83% | 2015 | 3.85% |
| 2004 | 5.84% | 2016 | 3.65% |
| 2005 | 5.87% | 2017 | 3.99% |
| 2006 | 6.41% | 2018 | 4.54% |
| 2007 | 6.34% | 2019 | 3.94% |
| 2008 | 6.03% | 2020 | 3.10% |
| 2009 | 5.04% | 2021 | 2.96% |
| 2010 | 4.69% | 2022 | 5.34% |
| 2011 | 4.45% | ||
Rules of thumb for home affordability
You can follow one of several rules of thumb to determine whether you can afford a house. Here are the more widely used.
The 28/36 rule
According to the 28/36 Rule, a household should spend no more than 28% of its gross monthly income on housing expenses (including mortgage payments, property taxes, and insurance) and no more than 36% on total debt payments (including housing expenses and other debts such as credit card payments, car loans, and student loans). Following this rule can help maintain financial stability and avoid overextending your budget.
The 2.5 times rule
Another rule of thumb for home affordability is the 2.5 Times Rule, which suggests that the maximum price of a home should be about 2.5 times your annual gross income to ensure your mortgage payments remain manageable relative to your income. For example, if your annual income is $70,000, you should aim for a home price no higher than $175,000 ($70,000 x 2.5).
The 30% rule
The 30% Rule states that your monthly housing costs (including mortgage payments, property taxes, and insurance) should not exceed 30% of your gross monthly income. This guideline helps to ensure that your housing expenses remain affordable, leaving room in your budget for other financial goals and living expenses.
Other factors to consider
Considering other financial factors helps you make informed decisions about home affordability, ensuring that you can comfortably manage homeownership costs while working towards your long-term financial goals.
Homeownership costs
Apart from the mortgage payments, there are additional costs associated with homeownership that can impact affordability, including:
- Property taxes: These taxes vary based on the location and value of the property. They vary by city, county, or district, depending on your state. Your local government website should have your area’s property tax rates.
- Home insurance: This insurance protects your home and possessions against damage or theft. The cost depends on coverage, property value, and location.
- Maintenance and repair costs: Homeownership requires ongoing maintenance and occasional repairs. Set aside funds to cover these expenses and consider them when determining home affordability.
Future financial goals
It’s also important to consider your long-term financial goals when buying a home. These goals may include:
- Retirement savings: Ensure you can continue contributing to your retirement accounts while managing your mortgage payments.
- Emergency fund: Aim to maintain an emergency fund covering at least three to six months of living expenses to handle unexpected situations.
- Children’s education: If you have or plan to have children, consider their education expenses and how your mortgage payments might impact your ability to save for their future.
FAQs
I make 70k a year how much house can I afford?
Using the 2.5 Times Rule as a rough guideline, you can estimate the maximum home price you should consider based on your annual income. With an annual income of $70,000, the calculation would be:
$70,000 (annual income) x 2.5 = $175,000 (maximum home price)
According to this rule of thumb, you should aim for a home price no higher than $175,000.
How much house can I afford with a 100k salary?
According to the 2.5 Times rule, which gives you a rough estimate of your home affordability, you can afford a house priced at $250,000 or lower.
What does home buying power mean?
Home buying power refers to a homebuyer’s ability to purchase a property based on their financial situation, including factors like income, credit score, savings, and debt levels. Basically, it represents the maximum amount a buyer can afford to spend on a home while maintaining financial stability and meeting other financial obligations.
How much must you make a year to afford a $500,000 house?
Typically, mortgage lenders suggest that the maximum home price you can afford is between 2.5 to 3 times your annual income. So, to purchase a $500,000 house, you would need a minimum income of around $166,667.
Can I afford a $500k house on a $200k salary?
Yes. Based on the 2.5 to 3 times annual salary rule, a $200,000 salary makes you eligible to afford a $500,000 house. However, this rule is only a general guideline. It may not consider other factors that influence your specific financial situation, such as your down payment, credit score, debt-to-income ratio, and other housing-related expenses.
Related Articles:
