Figuring out how much house you can afford is not simply calculating the largest mortgage payment you can make. Several factors go into figuring out how much house you can afford—let’s start with income and expenses.

Household income

Begin by calculating how much you, along with your spouse, partner, or others with whom you intend to purchase the home, receive each month in revenue. This could be your salary from full-time employment, income from a part-time job or business, investment returns, rental income, alimony/child support, or gifts.

Anticipated housing costs

Next, add up the total down payment you intend to lay out, along with estimated annual property taxes, homeowner’s insurance costs, mortgage insurance costs (required for down payments less than 20 percent), HOA dues, and the loan term. While this might be difficult to know all costs at the beginning, it’s a good idea to get the best estimate possible.

Household expenses

Finally, tally up your total household expenses outside of housing costs. These include car payments, credit card payments, health insurance, student loans, and retirement savings, plus food, gas/transportation, and entertainment. The more accurate you are about your spending, the more accurate a picture you can obtain about what you can reasonably afford on a monthly basis moving forward.

Luckily, most home buying websites like Zillow and Trulia provide calculators that incorporate such expenses as taxes, insurance, and HOA, to help you get a clearer idea of what your monthly payment might be.

However, other expenses lurk, and while there may be sudden, unexpected changes to your household income, or a rainy day here or there, you want to be able to predict and control your payments—especially as they relate to your home—as much as possible.

To determine how much house you can afford, most financial advisers agree that people should spend no more than 28 percent of their gross monthly income on housing expenses and no more than 36 percent on total debt—that includes housing expenses plus obligations like student loans, car payments, and credit card payments. The 28/36 percent rule is the tried-and-true home affordability rule that establishes a baseline for what you can afford to pay every month.

Of course, your mortgage’s interest rate also plays a large role in affordability. A low interest rate can save you tens of thousands of dollars over the life of your loan, so it makes sense to try and obtain the lowest rate possible. There are essentially three factors that go into securing your interest rate:

Credit Score

Borrowers with high credit scores are generally preferred. A high score with strong credit history demonstrates your ability to pay debts regularly and on time.

Debt-to-income ratio

As another measure of your ability to assume more debt, there is the debt-to-income ratio (DTI), which compares your monthly income to your monthly debt. People with high debt relative to their income will have a higher DTI and vice versa. The higher your DTI, the harder it will be to get a mortgage, much less a good interest rate. You want to strive for a DTI below 43 percent.

Down payment

The larger the down payment, the better the mortgage rate because lenders are risking less money. The loan-to-value ratio, or LTV, takes into account your down payment. The bigger the down payment, the lower the LTV and the less risk the lender will assume.

However, large down payments may not always be feasible or practical. There are many first-time homebuyer, government and needs-based down-payment assistance programs available for buyers with no or low down payments. Contact us today to discuss these alternative programs for which you may be eligible. Knowing how much house you can afford can help you take financially sound next steps.

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