If you’re ready to buy a new home, the first question you need to ask yourself is — how much house can I afford?
To help you make a well-informed decision, we’ll share 12 factors that can affect mortgage affordability, two rules of thumb to give you a ballpark estimate, a few real-world examples, and a helpful calculator for exploring different options.
So, how much home can you afford? Let’s figure it out!
Home Affordability Calculator
If you’ve been looking for a “how much house can I afford” calculator, you’ve found it! By using our home affordability calculator, you can see what a realistic mortgage looks like based on your financial estimates and other details. You can also evaluate which scenarios work better for your situation. For example, you could compare 15 and 30-year mortgage terms.
Keep in mind that while the home affordability calculator is a useful planning tool, you should always speak to your financial advisor or mortgage broker before moving forward. It’s also important to define all the factors that go into the affordability calculator. Let’s talk about that next.
How to Calculate Home Affordability
Looking for a quick answer to “how much can I spend on a house” is not always possible. There are a lot of factors to consider. But don’t worry, once you understand these 12 factors, you’ll feel more confident in calculating a comfortable range. Let’s discuss each one and how they affect how much house you can afford.
Annual Income
Naturally, your annual income is one of the biggest factors in how much mortgage you can afford. When you do any calculations, be sure to use your net income. In other words, what you make after taxes or your “take-home” pay.
Monthly Debts and Expenses
Annual income only gives lenders a partial picture of your financial health. They also must consider your monthly debts and expenses. You’ll need to add up any recurring debts, such as student loans, car payments, or credit cards.
Debt-to-Income (DTI) Ratio
To calculate your DTI ratio, take your total debt amount and divide it by your gross income (including taxes). For example, if your debt is $4,000 per month and your monthly gross income is $12,000, your DTI is $4,000 ÷ $12,000, or 33 percent. Most lenders want your DTI to be under 36 percent.
Down Payment
A down payment is the cash you pay upfront to get a home loan, typically a percentage of the total sales price of the house. If you make a down payment of less than 20 percent, most lenders will require private mortgage insurance or PMI. Borrowers pay PMI until they have accumulated 20 percent equity in the home. It’s typically .5 to one percent of the loan balance. You’ll have to weigh the costs of waiting to save more for a down payment versus paying PMI.
Credit Score
Your credit score is a three-digit number that predicts how likely you are to repay debt. Credit scores are calculated using your payment history, the amount of debt you have, and the length of your credit history. The higher your score, the more likely you’ll receive favorable credit terms, which may translate into lower payments and less interest.
Interest Rates
The interest rate on your mortgage represents a payment to your lender for servicing the loan. The interest rate can either be fixed or variable. A variable interest rate is tied to a benchmark interest rate known as an index. When the index changes, your interest rates also change. Your lender will determine your mortgage interest rate based on the general interest rate market and their assessment of your likelihood to repay (based on your credit score).
Loan Term
While a 30-year term is the most common mortgage option, choosing a shorter term will significantly reduce the amount of interest you pay over the life of the loan. However, it will also make your monthly payments higher, so you have to evaluate what would work best for you, based on your current and future earning potential.
Closing Costs
Closing costs include a variety of expenses such as attorney fees, title transfer, taxes, and lender costs. You may also be able to negotiate with the home seller or your lender to cover some of these. The amount varies according to the size of your loan and tax laws in your area, but on average, closing costs are two to five percent of the purchase price.
Property Taxes
Your property taxes are based on the tax rate for where you live and the value of your home. For example, if your home is worth $200,000 and your local tax rate is 1.5%, your property taxes would be $3,000 annually. This is separate from your mortgage payment, so you need to budget for this additional expense once you’re a homeowner.
Home Insurance
Homeowners insurance provides financial protection for your home and belongings in case of disaster or theft. The average annual premium is around $1,200, but costs vary depending on where you live and the size of your home. This should also be added to your new budget.
HOA
A homeowners association (HOA) is an organization makes and enforces rules for properties within its jurisdiction. If you purchase a home that’s part of an HOA, you’ll have to pay HOA fees, which go toward property maintenance, improvement, and community amenities. If you’re considering a condominium or planned community, be sure to factor these added fees into your budget.
Homeownership Costs
As noted above, many new homeowners overlook property taxes, home insurance, and (if applicable) HOA fees. When you calculate what mortgage you can afford, be sure to factor these into your budget. You should also consider the costs of regular maintenance. Plus, assuming you own a house for many years, you may need to repair, overhaul, and/or replace several expensive items, such as the roof or furnace.
What’s the Rule of Thumb for Mortgage Affordability?
Now that you have a better understanding of all the factors you should consider, another way to calculate what mortgage you can afford is by using generally accepted “rules” that bring these elements together. Like the home affordability calculator, these should be taken as guidelines only. However, they’re another helpful tool to answer the all-important question of how much mortgage can I afford.
Multiply Your Annual Income by 2.5
In this rule of thumb, you begin with your gross annual income. That’s the income from your W-2 (before taxes are removed). Multiply this number by 2.5 to estimate the maximum value of the home you can afford. However, keep in mind that the lower the interest rate you can obtain, the higher the home value you can afford on the same income. This is why your credit score is so important. Let’s take a look at a few examples.
How much house can I afford if I make $50K per year?
On a 50k salary, how much mortgage could you afford? According to this rule of thumb, you could afford $125,000 ($50,000 x 2.5). Let’s say you have a 4.5 percent interest rate and choose a 30-year mortgage. Your monthly mortgage payment would be $633. With interest, you’d pay a grand total of $228,008.
How much house can I afford if I make $70K per year?
Let’s look at a mortgage on 70k salary. Assuming the same 4.5 percent interest rate and a 30-year term, you could afford a mortgage of $175,000 ($70,000 x 2.5). This translates into $887 per month, totaling $319,212 after 30 years.
How much house can I afford if I make $100K per year?
If you’re wondering with 100k salary how much house can I afford, the 2.5 rule gives you a mortgage of $250,000. Using a 4.5 percent interest rate and a 30-year term, this translates into $1267 monthly, which equals $456,017 over 30 years.
How much house can I afford if I make $200K per year?
A mortgage on 200k salary, using the 2.5 rule, means you could afford $500,000 ($200,00 x 2.5). With a 4.5 percent interest rate and a 30-year term, your monthly payment would be $2533 and you’d pay $912,034 over the life of the mortgage due to interest.
The 28/36 Rule
Lenders often use the 28/36 rule to determine how much house you can afford. Unlike the 2.5 rule, this calculation can help you factor in more than just the mortgage amount. Here’s how it works.
- Front-End Ratio – Your monthly mortgage payment should be no more than 28 percent of your pre-tax monthly income. This includes property taxes, homeowners insurance, private mortgage insurance, and HOA fees (if applicable).
- Back-End Ratio – Your total debt should be no more than 36 percent of your pre-tax income. We defined this earlier as your debt to income ratio, but it’s also referred to as your back-end ratio.
Let’s work through an example. The table below shows what we’re using to demonstrate the calculations, but you can replace these numbers with your own estimates. In our scenario, we’re assuming an annual gross income of $100,000 and total debt of $10,000. Would this allow someone to afford a mortgage of $200,000?
In the above scenario, a person making $100,000 in gross income with $10,000 of debt would meet the 28/36 criteria. Here’s how:
Front-End Ratio
- The annual gross income of $100,000 works out to $8333 on a monthly basis.
- Monthly housing expenses should be less than 28 percent of $8333, which is $2333.
- Since monthly housing expenses would be $1324 for a $200,000 mortgage, that means the front-end ratio is 16 percent, well below the required 28 percent.
Back-End Ratio
- With $10,000 in total debt, that adds $833 per month, for a total of $2157 in monthly expenses.
- Total debt should be no more than 36% of your monthly gross income, which is $3000.
- Since total monthly expenses are $2157, that’s 26 percent of your income. This is under 36 percent.
So What’s Next?
Hopefully, you now have a better sense of your mortgage affordability. By understanding the variables involved in purchasing a home and how they affect what you can afford, you’ll be prepared to make smart decisions. To learn more, we encourage you to read our guide, 10 Steps to Buying a Home.
When you’re ready, you’ll want to select an agent to guide you through the process and get pre-approved by your bank. That way, you’ll know how much they’re willing to lend you. But keep in mind, just because you qualify for a specific amount doesn’t necessarily mean you can afford it. Be sure to consider your entire financial situation and choose a mortgage budget that fits your needs – now and in the future.
