Buying a house is a huge life milestone that comes with a lot of emotions. Most of us only buy a few homes in our lifetime so it’s not something we are completely familiar with. That’s why it’s important to work with trusted professionals to provide guidance and expertise.

Purchasing a home is a decision that will impact your financial situation for the next 15 to 30 years. So, first things first – calculate your monthly income and expenses carefully to avoid winding up with a mortgage loan you can’t afford BEFORE you head out shopping.

Understanding how much you can comfortably spend on a new mortgage while still meeting your existing obligations is a crucial first step in the home-buying process. How much house you can afford will depend on:

• Your loan amount and mortgage term
• Your gross monthly and annual income
• Your total monthly debt or monthly expenses, including credit card debt, student loan payments, car payments, child support, and other expenses
• State property taxes, which are paid annually or biannually and vary by state
• Current mortgage rates and closing costs
• Homeowner’s association (HOA) and condo fees

Understand The 28%/36% Rule

Most experts and lenders use the 28%/36% rule to determine your ability to afford a new home. The 28%/36% rule states:

• Housing expenses should be no more than 28% of your total pre-tax income. This includes your monthly principal and mortgage interest rate, home insurance, annual property taxes, and private mortgage insurance payments (PMI).
• Total debt should not exceed 36% of your total pre-tax income. This includes the housing expenses mentioned above as well as credit cards, car loans, personal loans, and student loans, so long as these monthly debt payments are expected to continue for 10 months or more. This does not include other monthly expenses such as groceries, gas, or your current rent payments.

The 28%/36% rule is a starting point for determining home affordability, but you’ll still want to take your entire financial situation into account. This will keep you from being “house poor” and leaves plenty of room in your budget to work toward other goals such as saving for retirement or your kid’s college.

Here are a couple of examples.

If your monthly mortgage payment, with taxes and insurance, is $1,260 a month and you have a monthly income of $4,500 before taxes, your Debt-to-Income (DTI) is 28%. ($1,260 / $4,500 = 0.28)

You can also reverse the process to find what your housing budget should be by multiplying your income by 0.28. In the above example, which would allow a mortgage payment of $1,260 to achieve a 28% Debt-to-Income. ($4,500 X 0.28 = $1,260)

Use our handy mortgage calculator to run some scenarios.

Down Payments

Remember, your down payment makes a difference in how much house you can afford. The more you put down, the less you need to borrow, which means a lower mortgage payment each month.

Try to save up 20% of the home price for a down payment. If you’re a first-time home buyer, a 5-10% down payment is okay but know that you will have to pay private mortgage insurance (PMI) for anything less than 20% down. PMI is another expense on top of your mortgage and is designed to protect the mortgage company in the event you can’t/don’t make your mortgage payment and they have to foreclose on the home.

The Interest Rate

The affordability of your home also depends on the rate you will be charged. Your rate will be based on four big factors:

1. Your debt-to-income ratio.
2. Your history of paying bills on time.
3. Proof of steady income.
4. The amount of your down payment, along with a financial cushion for closing costs and other expenses you’ll incur when moving into a new home.

Your credit score is the biggest determining factor for the mortgage rate you’ll get. Naturally, the lower your interest rate, the lower your monthly payment will be.

If you have questions about any step in the mortgage process, we’re ready to help.