February 28th, 2019 9:22 AM by Jackie A. Graves, President
much house can you afford? Knowing you want to buy a home is one thing; knowing
how much of a mortgage payment you can handle is quite another. Too often,
dreams and reality collide: You're yearning for a four-bedroom Colonial, but
given your income and debt owed to credit cards and beyond, the best monthly
loan payment you can manage is for a two-bedroom bungalow in a sketchy party of
how do you pinpoint a house where the monthly mortgage payment is financially
within your reach, and one that won't drive you deep into debt? Allow us to
help you paint your payment profile picture and find that magic number.
Why your mortgage payment depends on your income
a ballpark estimate of how much house you can afford starts
with looking at your income, or how much money you're pulling in.
general rule of thumb is that you can purchase a home that costs two or three
times your annual income," says Harrine Freeman, a
financial expert and the owner of H.E. Freeman Enterprises.
So if you're
earning $80,000 per year (and you have a reasonable amount of job security
and don't expect wild fluctuations in your income anytime soon), you can afford
a house up to three times that, or $240,000.
said, income isn't everything, and this is just a ballpark figure to get you
your income is only an estimate and does not account for your monthly
bills," says Freeman. So let's dive into more specifics on what makes your
payment pass muster.
is only half the picture of what determines the monthly mortgage payment you
can afford. The other half is your debt—meaning the debt you owe to credit
cards, college loans, and other credit sources. Even if your income is high,
having high credit debt means you have less money to put toward a monthly
One way to
factor your income and credit debt into how much mortgage you can afford is to
follow the 28/36 rule, a simple but effective ratio for mortgage
“28" refers to your monthly housing payment—things such
as mortgage, home insurance, and property taxes—which shouldn't be
more than 28% of your gross monthly income (ideally this payment should be less). This
payment is easy to calculate, because all you need to do is multiply. For
example, if your gross (meaning before taxes are taken out) monthly income is
$6,000, you would multiply that by 28% (or 0.28), which equals $1,680—this is
the maximum amount of your monthly housing payment.
refers to your debt-to-income ratio. This ratio compares your debt, or how much
money you owe (to credit cards, colleges, car loans, and—hopefully soon—a home
loan) to your income. This ratio should be “no more than 36%,"
says Freeman; ideally, this ratio should be much lower.
this ratio in terms of your monthly expenses: If you have a monthly income of
$6,000 but also spend $500 paying off credit cards or other debt, you would
divide $500 by $6,000 to get a debt-to-income ratio of 8.3%.
This ratio is great, but adding $1,680 in monthly mortgage payments
would push up your debt load to $2,180 and your debt-to-income ratio to 36%. This
ratio is exactly the maximum experts say you can afford. Going past
this threshold is a risky move. Ignore this ratio, and you could end up with a
house that, over time, could drive you even deeper into debt.
Last but not
least, the amount you have for a down payment matters, too. Ideally, to get the
best mortgage rates and terms, you'll want a down payment amounting to 20% of
the price of the house. But if you don't have that much, rest assured you can
put down less. FHA loans, for instance, need a down payment of only 3.5%.
Once you know
both the down payment you plan to contribute as well as your monthly income and
debt, you can easily work out the maximum monthly mortgage payment
you can afford—and by extension, the priciest house you should buy.
realtor.com®'s Home Affordability Calculator,
if you earn $6,000 monthly, pay $500 monthly in debts (pre-house), and
can make a down payment of $40,000, if you get a 30-year fixed
mortgage at 4% interest you can afford a house worth $277,800. Plug in your own
numbers and see what happens!
way to get a sense of how much you can comfortably pay in monthly mortgage
payments is to approach a mortgage lender and apply for mortgage pre-approval.
That's where the lender will take a look at your income, debt, credit score,
credit report, and other factors of your financial past to determine how
much money it's willing to loan you to buy a home.
you're not sure what your credit score is or
why it matters, here's a quick crash course: A credit score is your track
record paying off past debt you've had on credit cards or college loans. The
better your credit score, the better your odds of landing a great mortgage.
(You can check your credit score for free at CreditKarma.com.) If your payment
to debt sources has had some rough patches via late or missing payments, this
could stand against you. The good news? If you take care of past debt and make
your monthly payments on time, you can improve your credit score over time.
pre-approval doesn't just tell you exactly how big your monthly mortgage
payment can be. As a bonus, pre-approval also makes you a more attractive buyer
to home sellers, since they know you have financing to back up your offer.
to your down payment and monthly mortgage payments, you'll want to budget for
some other costs. The big one is closing costs, which are fees related to
processing your loan that can range from 2% to 7% of your home's price. Closing
costs aren't paid monthly; rather they are due at closing, when you get your
keys. So make sure to set aside enough money to cover this sizable expense!
The other big
ongoing expense to factor into your monthly budget is property taxes. Property
taxes are often folded into the monthly payments you'll find in a mortgage
calculator, but they're worth examining as a distinct factor since
they vary greatly by area. So, you'll want to check property taxes
carefully. You can typically find the exact amount (or an estimate) of the
property taxes you'll pay on real estate listings, or by entering your address
into an online home value estimator. (Here's more on how to calculate property taxes.)
housing expense to keep in mind is homeowners insurance. This is also factored
into payment estimates made by realtor.com's mortgage calculator. One ballpark
payment to keep in mind is that the average annual premium costs just shy of
$1,000. This payment will vary by area and home, too. You can often break up
this payment into small monthly installments so you won't feel the pinch quite
determined how much you can afford as a monthly mortgage payment, you can
confidently embark on your house hunt!
certain mortgage payment ceiling in mind, based on concrete numbers like your
monthly income and debt, means you won't end up busting your budget. You can
choose a house that fits comfortably in your payment profile, so you know you
can handle the monthly bills with ease.
If you find
your monthly income and mortgage budget aren't enough to snag the type of home
you want, you'll have to start weighing what you absolutely must
have in your home—and what you're willing to sacrifice if
Use the “pick
2" rule: payment, quality, location. Typically you can prioritize two
of those categories, but not all three. Your best bet is to stick to an amazing
neighborhood for an amazingly low monthly loan payment, and know that your home
might not have that pool, wine cellar, or other amenities you'd hoped for.
trade-offs are just the reality of scrounging together enough of a payment to
manage a mortgage and a house without getting sucked deep into
debt—so don't be disheartened.
monthly payments are falling short of your dream house, try widening
your search to different neighborhoods or knocking a few items off your must-have
list until you find the location and amenities that best fit your budget. Weigh
what really matters for your dream home, then start performing preliminary
searches online using sites such as realtor.com. And try to stay
searching and some luck, you can find a dream house that not only has all the
features you want, but also meets your payment profile—from your income to debt
to credit score and more.
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