10 Rules of Thumb to Determine How Much House You Can Afford
How much house you can afford is determined by factors like your credit, debt-to-income ratio, and existing monthly costs.
Think you’re financially ready to buy a house? Before you make appointments with real estate agents and lenders, you should make sure you’ve taken an honest assessment of your income and expenses, so you know just how much home you can afford. Doing this will help your agent find the best homes for you within a price range that won’t break the bank.
To help ease this part of the process, we’ve compiled a strategy to review your finances and 8 simple rules of thumb that lenders often use to determine how much they will loan to a buyer.
Step one: Talk to a few buyer’s agents!
Tell us a little bit about your plans (where you’re looking to buy and when you want to make a purchase) and we’ll connect you with top-rated buyer’s agents in your area. It takes only a few minutes, and it’s free.
The costs around buying a house
When you think about the primary cost of buying a house, the down payment is probably the first thing that comes to mind, and for good reason: It’s definitely going to be the heftiest cost associated with the purchase. That said, you might not need the 20% that you’ve heard you need — in fact, the average down payment for first-time homebuyers is 6% to 7%. Of course, the more you put down, the lower your mortgage payments will be, so it’s important to calculate your budget.
But the down payment is only the tip of the iceberg. In addition, you’ll need to budget for these costs:
- The appraisal: $300 – $500 on average
- The inspection: $335 on average
- Closing costs: 2%-5% of the home’s purchase price on average
And after the deal closes, you’ll need to factor in taxes and homeowner’s insurance. The national average for taxes is $3,126 annually, but this cost could be much higher or lower depending on where you live. As for insurance, you’ll probably shell out around $2,728, but this also can vary greatly based on where you live and depends on a variety of factors — whether or not your home is in a high-crime area, a flood zone, or has a pool, to name a few.
1. Existing monthly costs
Make a list of all your monthly costs in order to understand what percentage of your income is currently devoted to bills. Here are some common bills you should be sure to include if they apply to you:
- Credit card debt
- Car payments and car insurance
- Student loans or tuition payments
Before we get into the nitty-gritty, be aware that every lender is going to use a different rule (or set of them).
Top real estate agent Joe Bourland in Phoenix (he’s been helping buy and sell homes for 24 years) says that he urges homebuyers to shop around (or use a mortgage broker) because unless you have a credit score of 800 and no debt (which you probably don’t, because you’re human like us), different lenders will use whichever rules they prefer, ultimately giving you several different options to choose from.
Now, let’s get to the rules!
2. The 28% rule
If you’re following this general rule, you shouldn’t spend more than 28% of your gross income (what you take home before taxes) on your mortgage payment (principal and interest).
Example: If your household income is $100,000, then you can afford to spend around $2,300 on your mortgage principal and interest per month; with these numbers, and assuming you have good credit (a score of 680+) and 6.7% for a down payment, then you should be looking at homes priced around $450,000.
3. The 28% / 36% rule
This rule takes the 28% rule one step further. It states that your total household debt shouldn’t exceed 36% — so after you factor in the 28% for your mortgage principal and interest, you only have 8% remaining for the rest of your bills, including car payments, student loans, and credit cards.
Example: If your family has a monthly income of $5,000, they could budget for a $1,000 monthly mortgage payment (principal and interest) and have $800 remaining for their other bills. Assuming these numbers, you’d want to look for homes priced around $165,000.
While not every lender is the same, the 28% / 36% rule is a common standard for determining your ability to take on a certain size mortgage.
