When you are ready to buy a home, whether for the first time or the tenth, it is always important to know how much you can afford to spend. This will help you narrow your home search and ensure you do not get in over your head financially. There are several factors to consider when determining how much house you can afford.
Mortgage lenders will evaluate your debts relative to your income. The standard rule of thumb for debt-to-income ratios is 28/36. The first number means lenders prefer that your total housing debt- including your new mortgage, taxes, HOA fees, private mortgage insurance, etc. – is less than 28% of your total income. The second number refers to your total debt – mortgage, car loans, student loans, credit cards, etc. – which lenders prefer to be less than 36% of your income. Of course these ratios will vary slightly by lender, but the lower your ratios, the better your chances of finding funding and getting good interest rates.
How much you can afford for a house will also be determined by your credit history and FICO score. These factors will influence what type of mortgage you can qualify for and how low the interest rate will be. If your credit score is less-than-perfect, your mortgage interest rate will be higher, making your monthly payment higher and reducing how much you can actually spend on a house. If your credit profile is not as clean as you would like it to be right now, you can take steps to improve your FICO score before applying for a mortgage.
Most home loans require a down payment, even if it is just 3% of the purchase price. (There may be some exceptions in FHA loans and VA loans.) The more you have to contribute as a down payment, the more attractive you will be to sellers and the more attractive your loan options will be. A 20% down payment is ideal because with any less than that you will have to pay private mortgage insurance which pushes up your monthly payment and cuts down your home price budget.
Beyond coming up with these numbers, you should consider your lifestyle when it comes to how much you can afford. Buying a home can come with many hidden costs – repairing and replacing various parts and appliances, HOA dues, higher utilities, yard work, renovation – and those can eat into your budget for other things like entertainment or savings. It is important to set a house budget that will give you enough cushion to still be able to pay for not only the essentials of food and transportation, but also for your retirement goals, savings for college, and vacation plans.
With some careful calculations on your own and possibly with the help of online tools, you can figure out how much home you can truly afford without stretching your resources too thin. When you buy a house within that budgeted price range, home ownership can be just as enjoyable as you have dreamed it would.