How Much House Can I Afford Without Feeling Strapped Every Month?

You’re ready to put down roots, build up some equity, and find a place called home. Your bank account looks solid, and you’ve been on stable financial footing for a while now. Buying a house just feels like the natural next step in your life… and that’s an exciting place to be.

Before you set out to find the perfect abode where you’ll one day pop champagne in an empty kitchen, you’ll need to take a hard look at your finances and get familiar with what it means to be a homeowner. The truth is that houses are expensive, long after the closing celebrations fade. Many buyers fail to grasp that. In fact, 82% of millennial buyers have regrets, with the most common being related to paying too high of an interest rate.

This guide will take into account all the variables, from mortgage basics to those tricky extra costs like taxes, insurance, and maintenance. From here, you’ll be able to create a budget based on smart money management and what professionals across the real estate and finance industries recommend.

Ready to crunch the numbers now? HomeLight’s created a Simple Home Affordability Calculator to help you safely budget and to answer the critical question: How much house can I afford? in a way that won’t lead to a grocery cart full of ramen down the road.

But if the thought of juggling mortgage payments, HOA fees, and maintenance costs (on top of everything else you have to pay for) makes your head spin, you’ll need a little more help. Pick up your pocketbook —  let’s make a plan.

Step 1: Tally up those paychecks: How much money comes into your house every month?

To calculate your home shopping budget, you’ll need to start with your income. You should be familiar with two different numbers:

1. Your pre-tax income

Your pre-tax income, also called your “gross income,” is the amount of money you make before deducting for state and federal taxes. People know their pre-tax salary off the top of their head. It’s that high-level number you think of when you say, “I make this much per year.”

Your gross income is also what mortgage companies will use when they calculate how much money they’re willing to lend you. Your pretax income tends to be more stable and measurable, since not everyone knows what deductions and taxes they’ll pay at year’s end.

If you’re buying a home with a partner, you should add your pre-tax incomes together to get your full buying power. Those who work multiple jobs will need to do some math to put together their various income streams.

Keep in mind that nontraditional sources of income, such as commissions and bonuses, may be treated differently depending on the lender and loan program. In most cases, for example, lenders will require a two-year commission history before they factor that income into your loan qualification.

2. Your take-home pay

Lenders look at your gross income, but you should also know how much money is yours to spend every month since much of what you earn pre-tax is cash you’ll never see. Check out your monthly pay stub to get this number.

Step 2: Figure out your maximum mortgage payment based on your income and current debts

Once you have an idea of your positive cash flow each month, you can figure out how much of it could comfortably go toward a mortgage.

Lenders will look at what’s called your debt-to-income (DTI) ratio, a measure of all your monthly debt payments (think: housing, credit card, car, and student loan payments) as a slice of your gross monthly income, to determine what size loan you qualify for. Per the Qualified Mortgage rule adopted in 2014, most lenders require that your DTI be no higher than 43%.

That means if you had no other debts, most lenders would let you borrow up to 43% of your income. However, many personal finance experts would consider that to be a budget stretch. That’s why you need to have your own budget limits set first.

Depending on how much money you put toward debts each month, you’ll have a little wiggle room to decide whether you’d like to stay on the conservative side or increase your budget for the right home. It’s a personal decision, but the more you spend on housing costs, the less money you’ll have for other expenses, emergencies, and opportunities. Go too far in this direction and you’ll end up “house poor,” aka the person in your friend group who can’t afford to do anything fun.

With that in mind, here are three simple rules to consider for calculating your maximum mortgage payment:

The rule of 30

HomeLight spoke with a variety of personal finance experts, and many of them brought up the rule of 30 as a measure of financial responsibility.

It means that “a person’s home payment should be no more than 30% of their gross income each month,” including taxes and insurance, says Mike Scott, a mortgage professional with more than a decade of experience in the industry.

Simple enough.

Super saver

Financial expert Dave Ramsey believes in a more conservative approach. He recommends that your housing costs shouldn’t exceed 25% of your after-tax income. (He’s also a big advocate of the 15-year mortgage for those who can swing it).

Refer to the after-tax income you calculated above, and follow this rule if you like the freedom of having plenty of disposable income to play around with every month.

Dinner out on the town? You’ll be there, and be able to pay your mortgage to boot!

Example:

To illustrate, let’s suppose you and your partner bring in the average American pre-tax household income of $60,000, or $5,000 per month. You’ve decided to follow the rule of 30 recommended by personal finance experts and cap your housing costs at 30% of your pre-tax income. You’re aware that your total debts won’t be able to exceed 43%.

We’ll call it the 30/43 plan:

Calculation 1: mortgage payment
$5,000 (income) * .3 (maximum housing costs) = $1,500

Calculation 2: debt
$5,000 (income) * .43 (maximum debt) = $2,150

Using this method, your house payment shouldn’t exceed $1,500 a month, and your total debts shouldn’t exceed $2,150. If you already pay $350 a month toward your car and $400 for student loans, you’d need to subtract that from your debt maximum, like so:

$2,150 (the amount you can pay toward debts every month, including housing payments)

-$350 (car payment)

-$400 (student loans)

=

$1,400 maximum mortgage payment

To keep your DTI in check, you could spend a total of $1,400 on:

Mortgage principal and interest
Taxes
Homeowners insurance
Private mortgage insurance (if applicable)
HOA fees (if applicable)

Finally, if you have no debts or your debts are less than $650 per month ($2,150- $1,500) then your mortgage and associated housing costs budget remains at $1,500 per the rule of 30.

But you may be wondering: what are these extra costs that come with your mortgage? Let’s break those down before we dive into interest rates, mortgage terms, and down payments.