How Much House Can I Realistically Afford?
Shopping for a new house, especially your first home, can be exciting but it can also be stressful as taking on a mortgage for as much as 30 years can seem daunting at first.
The key to reducing the stress of buying a new home is to know before you begin shopping how much house you can realistically afford.
This helps you narrow down your home options so that you avoid falling in love with a dream house you cannot afford.
The Rules of Home Affordability
There are several rules of home affordability that you need to understand before shopping for a new home. These are qualification ratios that mortgage lenders use to determine how much they will lend you for a new home. Although lenders may have their own specific qualifications, most are within a similar range to other lenders. The three rules include:
Rule of 28 – This rule states that your monthly mortgage payment should not be more than 28 percent of the income you take home before taxes are deducted, known as your gross income. If your income before taxes is $5,000 per month, your monthly mortgage payment should not be more than $1,400 per month
Rule of 32 – In addition to ratio limits on the maximum amount of mortgage payment you can afford, the lender will look at how all housing costs compare to your income. In addition to the mortgage, the following items are added together to determine your total housing costs:
- Homeowner’s insurance
- Private mortgage insurance
- Homeowner association or condo fees
- Property taxes
This total should not exceed more than 32 percent of your gross income. With that same $5,000 per month in gross income, the total payments related to your home could not exceed $1,600 per month.
Rule of 40 – The final rule that the mortgage company will follow is that your total debt payments, including mortgage, credit cards, vehicle or student loans, credit cards and other forms of debt should not exceed 40 percent of your gross income. Using the same $5,000 per month, this means that all of your debt cannot exceed $2,000. What this means is that the more debt you have, the lower the mortgage payment you qualify for will be.
Ratios are not written in stone, however. Some lenders allow for lower ratios while others have even higher limits, so it is important to discuss your specific circumstances with a financial advisor.
How to Calculate an Affordable Mortgage
Although it is difficult to determine how much your mortgage will be until you know what interest rate you qualify for, you can estimate the range of prices for houses you can afford to purchase.
Using an interest rate of six percent, you can roughly estimate that your mortgage payment will be around $650 per $100,000. In other words, at that interest rate, if you purchase a $150,000 home, your mortgage payment will be around $975. This means that with your gross monthly income of $5,000, your maximum mortgage amount would be just over $215,000.
If you can make a down payment of between 10 and 20 percent, you may be able to increase the maximum amount you can borrow. Keep in mind, however, that putting less than 20 percent down may require you to pay private mortgage insurance that will increase your non-mortgage housing expenses and impact your Rule of 32 ratio.
For more information about mortgages and how much mortgage you may qualify for, complete our contact form. A representative will contact you to discuss your circumstances and get you on your way to purchasing that new home in no time.