How much home can I afford?

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In a Nutshell

Conventional guidance says that you can afford to pay up to 28% of your gross monthly income on housing. But how much home you can afford also depends on your debts and how much you’ve saved for a down payment.
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If you’re planning to buy a house, you’ll need to figure out how much home you can afford.

Although deciding how much of your budget should go toward buying a home is ultimately up to you, there are general guidelines based on your income and debts that can help you zero in on a price range. Learning about lenders’ mortgage requirements can help you determine which homes are realistic options for you.

Keep in mind that a home’s asking price isn’t the only factor that goes into affordability. The interest rate on your home loan, your down payment and your loan term can all affect how much you end up paying for a home.

How much house can I afford based on my salary?

It’s standard advice that your housing expenses shouldn’t total more than 28% of your gross monthly income and that your total debts shouldn’t be more than 36% of your gross monthly income. (Gross monthly income is your monthly income before paying taxes, making contributions to retirement accounts or taking out other deductions.)

To find out if a house might be affordable for you, estimate your total housing expenses. Housing expenses include the principal and interest you pay on your mortgage. They also include mortgage insurance, property taxes, homeowner’s insurance and homeowner’s association fees, if you pay them.

Next, divide that number by your gross monthly income. For example, if you’re thinking of a total monthly housing payment of $1,500 and your income before taxes and other deductions is $6,000, then $1,500 ÷ $6,000 = 0.25. We can convert that to a percentage: 0.25 x 100% = 25%. Since the result is less than 28%, the house in this example may be affordable.

While the 28% rule is a good starting guideline, there are other factors to think about. Lenders are legally obligated to learn about your assets, expenses and credit history before offering you a mortgage. How reliable your income is also matters. If much of your earnings come from a source that varies from month to month, like commissions, a lender might not be willing to lend as much to you as it would to someone who earns a consistent salary.

In addition to deciding how much of your income will go toward housing, you should also consider how much a mortgage would add to your existing debts. You can then decide if you’d be able to keep up with all of your debt payments, and if you’d have enough room left over in your budget for food, healthcare and other spending categories.

What’s my debt-to-income ratio?

Lenders take into account the share of your income that goes to paying debts — or your debt-to-income ratio — when determining whether you can afford a mortgage. Qualified mortgages, which are mortgages that meet requirements designed to improve the chances that borrowers can pay them back, usually need to keep the borrower’s debt-to-income ratio below a maximum percentage.

The debt-to-income ratio is a measure that helps lenders estimate how easily you can repay your debts. When a person has a low debt-to-income ratio, it means that their debt payments make up a small portion of the total amount of money they have coming in each month.

How to calculate your debt-to-income ratio

To find your debt-to-income ratio, first add together all of your monthly debt payments. For example, if you pay $200 each month on a student loan, $400 on a personal loan, and $500 on an auto loan, your total debt payments are $200 + $400 + $500, which equals $1,100.

Next, determine your gross monthly income.

Take your total debt payments and divide that number by your gross monthly income. Let’s say for this example that your monthly income is $4,000. Then your total monthly debt payments divided by your gross monthly income is $1,100 ÷ $4,000, or 0.275. We can convert the result to a percentage: 0.275 x 100% = 27.5%.

Why your debt-to-income ratio matters

Lenders care about your debt-to-income ratio because research shows that people with higher ratios are less likely to keep up with their loan payments. Also, federal regulations require lenders to look at your debt-to-income ratio, and you generally can’t get a qualified mortgage that would give you a debt-to-income ratio of more than 43%. In practice, many lenders want your debt-to-income ratio to be no higher than 36%.

How can I get a good mortgage rate?

The mortgage rate you’re offered has a big effect on whether you can afford a home. A lower interest rate can make a mortgage much less expensive, while a higher rate could put a house out of your price range.

Here are some factors that can change the interest rate you’re offered.

Credit history

Your credit history determines your credit scores, and higher credit scores typically help you qualify for a better interest rate.

Before you apply for a mortgage, check your credit reports to make sure everything in your credit history is accurate. If you find a mistake, ask the credit bureaus to correct it so it doesn’t hurt your chances of getting a good rate.

If your credit scores aren’t high enough for you to get the rates you’d like, you may choose to work on raising your scores before shopping for a home. Paying bills when they’re due, borrowing less than 30% of your credit limit and taking out a credit-builder loan and successfully repaying it can all help improve your scores.

But keep in mind that it’s not possible to raise your credit scores instantaneously, so you should plan to start rebuilding your credit at least six to 12 months before you want to buy a house.

Your down payment

Putting more money into your down payment usually lowers your interest rate. If you can, it’s best to make a down payment of at least 20%. Making a down payment of this size typically results in a better rate, and it also means that you probably won’t be required to buy private mortgage insurance, which would raise your monthly housing payment.

Loan term and adjustable vs. fixed rate mortgage

Loans with short terms usually have lower interest rates than loans that are paid off over a longer period of time.

An adjustable-rate mortgage might have a lower rate than a fixed-rate mortgage at first. But over time, the rate on an adjustable-rate mortgage could go up by a lot, while the rate on a fixed-rate mortgage would remain the same.

Should I wait to buy a home?

If you don’t qualify for the rates you’d like, have enough income to buy the type of house you want or have enough saved up for a large down payment, you’re faced with a tough decision: You can go ahead and buy a home now, or wait until you can more easily afford the home you’d prefer.

There are pros and cons to each option. If you wait, you may be able to get a better interest rate later, which could save you thousands of dollars in the long run. And buying a home means assuming the risk that the property’s value could fall, or that it might need expensive repairs sometime down the line. If you postpone a home purchase, you can put off those risks until you’re in a better financial position.

On the other hand, if you wait to buy a home, you won’t start acquiring equity. Because building equity can grow your net worth and give you better borrowing options, you may be better off if you begin that process sooner rather than later.

If you can’t afford to buy a home with a conventional loan, you might benefit from one of these government loan programs designed to make home ownership more accessible.

  • FHA loan — An FHA loan, which is a loan from a private lender that’s insured by the Federal Housing Authority, may be less expensive than a conventional loan if you don’t have strong credit scores or if you want to make a down payment of less than 10% to 15% of the home’s purchase price. But the amount of the loan must be lower than the program’s maximum amount for your area of the country, and you’ll have to purchase mortgage insurance.
  • VA loan — For members of the military, eligible veterans and surviving spouses, private loans guaranteed by the Department of Veterans Affairs are another option. You may be able to qualify for a VA loan with a low down payment, and while you don’t have to pay mortgage insurance each month, you’ll probably have to pay an upfront fee at closing.
  • USDA loan — You might be eligible for a USDA loan if you’re planning to buy a home in a rural area. There are also state and local programs that offer subsidized loans or help with down payments.

Next steps: Getting your finances ready to buy a house

Take stock of your finances to see if you’re ready to apply for a mortgage. Make sure that you can provide evidence of at least two years’ worth of regular income, and figure out your total assets, debts and monthly expenses.

Check your credit reports. If you want to apply for new credit cards or other loans, keep in mind that these applications may add inquiries to your credit history and could lower your scores. Plan to apply for other types of credit well in advance of applying for a mortgage or wait until after you’ve closed on your home loan.

Ask lenders what information they need from you to issue a mortgage preapproval letter, and confirm that you have the documents on hand.

Mortgage rates where you live

Mortgage or refinance rates depend on different factors, including where you live. To better understand what rates you may qualify for, including what the average mortgage or refinance rate is in your area, take a look at Credit Karma’s mortgage rate marketplace and our latest state-specific guides.

About the author: Sarah Brodsky is a freelance writer covering personal finance and economics. She has a bachelor’s degree in economics from The University of Chicago. Sarah has written for companies such as Hcareers, Impactivate and K… Read more.