How Much House Can I Afford? Expert Guide
Understand your overall financial situation – take time to review your credit score, debts, and income. So you are ready to buy a house but you’re just not sure how much house you can afford. Use the 28/36 Rule to determine your optimum budget.
Generally speaking, the 28/36 rule is a method used to determine the appropriate amount of debt for an individual or household. According to this rule, a household should not spend more than 28% of its gross monthly income on housing expenses and no more than 36% on total debt payments.
As an example, if you make $5,000 each month, or $60,000 annual income, your home loan payments should not be more than $1,400 per month ($5,000 X .28).
When calculating the housing ratio, include all your housing expenses, such as homeowners insurance, Homeowner Association fees, and property taxes along with your monthly mortgage payment.
You also can’t have all your other debts that add up to more than $1,800 per month ($5,000 X .36 ). When determining this calculation include all your monthly debt payments. Be sure to include all monthly payment(s) such as student loan payments, credit card debt, and any car payments and car loans to calculate the 36 % ratio.
How do current interest rates impact affordability?
Now that you know how much your monthly housing budget is, let’s see how interest rates affect this number.
Over the past year, the U.S. monetary policy department has stepped up rates to curb inflation. This increased the mortgage rate. When interest rates go up, the amount of house you can afford goes down. This happens for lots of reasons. It’s like getting less money for the same price.
- As interest rates go up, your mortgage loan costs will also increase, including the amount you’ll have to pay in interest and your monthly payments.
- This can slow down the housing market and result in fewer people selling their homes. As a result, there will be less housing inventory for you to select from.
- Moreover, if you have lower credit, higher interest rates may make it harder for you to qualify for a mortgage.
Just remember, higher interest rates usually reduce the affordability of a house. This is mainly because higher rates affect the ability of a bank to lend you the same amount it would if rates were lower.
Additionally, higher interest rates cause an increase in your monthly payment to accommodate the rise in interest that you will pay over the loan’s life.
The 1/10 Rule
Another important rule to remember, the 1/10 rule means that a 1% increase in interest rates will equal 10% less you can borrow but still keep your same monthly payment. The higher the interest rate, the higher your monthly payment.
As an example, a buyer qualifies for a $250,000 mortgage. If the interest rate suddenly hikes up 1%, the buyer’s purchasing power drops to $225,000:
$250,000 – $25,000 (10%) = $225,000.
Even though interest rates are higher now than they were last year and the year before, the current rates are still half of what they were a generation ago. This means this is still a great time to make a purchase!
How Much Should I Have Saved When Buying a Home?
Lenders often want to know whether you will have enough cash to pay back the mortgage once your home purchase is complete. A big down payment when you’re borrowing money is attractive to lenders because it reduces the risk they take on.
If you provide a bigger down payment, your monthly payments towards both the principal and interest of your loan will be smaller. Think of a down payment as a way to start paying off your home without having to pay interest.
Don’t forget to factor in closing costs
In general closing expenses are about 4 – 6 percent of the potential property’s value. Your mortgage lender or real estate agent can give you an estimate of what closing costs will be and give you a list of the costs.
For example, if you are looking to purchase a home with a purchase price of $200,000 just multiply it by 4%. Your closing costs will be about $8,000. Add your closing costs in when asking how much house you can I afford?
How to improve your home affordability
Here’s what you need to do first: find an affordable mortgage.
Start by researching different lenders and comparing their interest rates and terms. Look at total loan costs as well as the interest rate being offered. A lower interest rate can mean big savings in the long run. Here are some questions to ask when talking to your lender.
- Will I qualify for a FHA loan and what are the costs?
- Will I need private mortgage insurance?
- What are your loan terms? (make sure the quotes are for fixed rates not variable)
- How much will my total house payment be?
You can also improve affordability by saving for a larger down payment. This will lower your monthly mortgage payments and could even qualify you for a lower interest rate.
Get Pre-Qualified
There are plenty of resources to use to determine how much house can I afford?
The best way to proceed is to ask your mortgage lender to prequalify you before you start searching for a home.
Your mortgage lender will ask you how much down payment you have. They will look at your total monthly debt, your total monthly income. They will determine your debt-to-income ratio (which is a fancy way to say the 28/36 rule).
All these factors go into their calculation and they will tell you exactly how much house you can afford.
Research the area
Once you have your prequalification-start looking in different areas. It really is a zip code to zip code comparison. Draw a broad circle around your ideal area, there are usually little pockets of more affordable homes if you go further from the big metro areas.
Calculating how much house you can afford is an important step in the home-buying process
It’s best to calculate how much house you can afford before shopping for a home. This way you enter the market fully aware of potential purchase decisions.
There are numerous calculators online that can help you make this decision and there are also experts available that can assist you as needed.
Be sure to set a budget that works well with your finances, lifestyle and future goals. Remember, it’s always important to plan carefully when making a large investment like purchasing a home.
Not only will taking the time upfront save you money in the long-run, but also help give you peace of mind knowing that when all is said and done, you made the right decision for all parties involved.
Ready to start searching? Click here to find an agent and begin your journey into homeownership today!
