How Much House Can You Really Afford?

Spring is here and many people are looking for a fresh start. For some families that means looking for a new home. And with interest rates at a favorable level, many families will opt to purchase rather than rent. One of the first questions on the minds of most potential home buyers is how much house can I afford? And that answer depends on a number of things including the family’s debt to income ratio, their amount of cash reserves, and their overall credit profile. All these factors are used by mortgage lenders to determine how much house you can afford. You can use mortgage calculators to help you do the math consider these factors when determining how much house you can afford.

1.      What is the debt-to-income ratio?

One of the first items reviewed to calculate how much house a buyer can afford is their debt-to-income ratio, sometimes referred to as DTI. This number helps banks determine a potential borrower’s ability to manage the mortgage payments on the loan they acquire to purchase a home. According to the Consumer Financial Protection Bureau, the DTI is all your monthly debt payments divided by your gross monthly income. This number is usually represented as a percentage. The lower the percentage, the easier it is to manage the additional responsibility of a mortgage loan. As the percentage gets higher, lenders are less inclined to offer a mortgage to potential home buyers. Typically, borrowers want to stay below a 43% DTI to qualify for most mortgage loans.

To determine your DTI and ultimately how much house you can afford you will be asked to provide your household income from either salary or investments, your monthly debts car loans, utilities, groceries, student loan payments, credit card payments, etc. and the amount of cash available for a down payment.

2.      How much cash do I need to buy a home?

In addition to DTI mortgage lenders will also consider your cash reserves – the amount of money you have saved – that can be used to assist with the home purchase. This cash would be used for your down payment, closing costs, and other expenses that may be required to actually finalize the home purchase.  These funds can come from your investments, savings, or other verifiable sources.

For down payments, the amount of cash needed will most likely be determined by the type of loan you want. Most people have heard of the 20% requirement but if you’re getting an FHA loan backed by the Federal Housing Administration your down payment could be as low as 3.5%.

It is also a good idea to have cash reserves to manage your monthly payment after the purchase of the home is complete. A popular rule of thumb is to have three months of mortgage payments and other monthly debts in savings to help you cover your new mortgage payment in case of any unexpected event…like the pandemic.

3.      How does my credit score affect the mortgage I get?

This one is probably more clear than the rest. The higher your credit score, the easier it is to qualify for a mortgage loan. The lower your score, you may have limited options. Your credit scores affect the types of mortgages you qualify for, how much you can borrow, the interest rates you’ll pay and how much you’ll pay for private mortgage insurance. Generally speaking, you’ll want a credit score of at least 620 in order to be eligible for a loan. The higher your credit score is beyond that 620, the better. Some mortgage calculators or house calculator sites will even allow you to enter your score to see how it impacts your mortgage options.

4.      What’s the 28%/36% rule?

Another popular method to calculate how much house you can afford is using the 28%/36% rule. The rule is pretty simple.  First, the rule advises borrowers to make sure that their maximum household monthly expenses are not greater than 28% monthly income. Second, the rule is that your total monthly debt does not exceed 36% of your total monthly income (DTI).  The 28%/36% rule is a generally accepted starting point for determining home affordability, but you’ll still want to consider your household’s entire financial picture when considering how much house you can afford.

5. What if I need help?

If this is your first time considering buying a home or it has been years since you have gone through the process you should consider professional help. You could benefit from the help of a licensed and qualified realtor in your area and a banker or mortgage professional to help with financing. These professionals can help you with your search, understanding current trends in the market, and help find the right loan products for you and your family.