When most people start considering a home purchase, the first question that comes to mind is budget. How much house can I afford?
A lot of buyers sometimes mix the affordability question up with this question: how much can I borrow?
They are totally different.
Finding out how much you can borrow is as simple as getting pre-approved. A pre-approval letter from your mortgage advisor states how much a lender will allow you to borrow.
Easy peasy, right?
What it won't tell you is how much you can actually afford to comfortably borrow.
As you’ll see, there’s a big difference.
How much house can you really afford?
Mortgage companies do a good job of figuring out your pre-approval maximum based on your current income, debt, and savings, but 'maximum' and 'comfortable' are often dollar amounts worlds away from one another.
Now you need to figure out how much you’re willing to spend on a monthly house payment...not just now, but for potentially a very long time.
You'll probably have that home loan for a long time.
The pre-approval maximum is a formula that doesn’t take into account your spending habits, savings preferences, and lifestyle. It also doesn’t account for less quantitative aspects of your life, such as your future.
- Do you plan to have children soon, which would affect your monthly expenses, and potentially earning potential if you’re going to have one parent stay home with the kids.
- Do you have older parents who may need financial assistance that would detract from your ability to pay your own bills?
- How are your handyman skills? Are you prepared for the many costs of owning a home outside the mortgage? Or will your home fall into disrepair and suddenly require large chunks of your income to get things running smoothly again?
A multitude of factors determine how much money you could comfortably allot for a house payment each month, and the maximum pre-approval amount is most often way above the amount most people want to spend, if they’re evaluating their budget honestly.
How to calculate a house payment you could afford
Depending upon your situation and even your preferences, the exact mortgage payment you find affordable can vary quite a bit. Typically, people don't look at the total loan balance when they try to figure out what they can afford. Instead, they want to know how much they will pay every month for their mortgage.
These basic formulas give you different ways to roughly calculate suggested maximum monthly payments:
- Mortgage payments: The simplest calculation simply suggests that you should not pay more than 28 percent of your income for a home loan. If your household earns $10,000 a month, than you should not consider a monthly a principal plus interest payment greater than $2,800.
- Total cost of homeownership: You can make a burdensome mistake if you only consider your new mortgage payment as the total cost of homeownership. Add the sum for principal plus interest to future homeowners insurance, property taxes, neighborhood association dues, and some reasonable estimates for upkeep. This sum should total less than 32 percent of your total income. If your household earns $10,000, this sum should not be greater than $3,200.
- All debt: If you already have considerable debt, you should total it and then add in the total cost of homeownership, and that number should not exceed 40 percent of your income. With a $10K a month income, your total debt obligations should not exceed $4,000.
It's impossible to suggest using just one of these formulas. Factors like existing debt or local property taxes can vary so much.
If you're almost free of current debt you might think about buying a more expensive home than if you have student debt, a large car payment, and/or high credit card balances.
If property taxes and homeowners insurance premiums in one community push you over the threshold for the kind of house you hope to buy, you might either need to seek a cheaper community or adjust your ideas about the sort of home you really need.
You Can't Always Measure Home Affordability With a Formula
Beyond the numbers, you should also take some time to think about the lifestyle you hope to enjoy. If you plan to center your life around your new home, you may want to invest more money in housing and make other sacrifices. On the other hand, people who prefer to routinely venture out for entertainment, socializing, and travel may choose to minimize homeownership costs. You might also think about the impact of a move on such essentials as commuting to work or having access to public vs. private schools.
You should also consider how much of each spouse's income to use to qualify yourself for a mortgage. One frequent problem that younger couples run into is using both incomes to qualify for a large mortgage. After a few years, one spouse might choose to take a break from work or take a part-time job to spend more time with their growing family. It's much better to plan for this possibility in advance than to regret having the burden of a large mortgage later on.
Consider the Costs of Homeownership Vs. Housing Alternatives
The formulas and considerations above should give you a good way to start assessing affordability in cities with average housing prices. In some cities, typical families and individuals are forced to spend a much higher percentage of their income on housing. If you're tied to an expensive city, you may have to make different judgments about affordability.
According to a Zillow study published recently, experts, average buyers in the largest markets spend close to 30 percent of their income on housing payments, and in Los Angeles, it would take over 40 percent of the largest income to afford a median-priced home. In these situations, prospective buyers might do well to wait until they can reduce other obligations, accumulate a larger down payment, and consider the risks they might take by extending themselves.
How to Determine an Affordable Mortgage for You
How do you figure out how much you can afford to pay to buy a home? You'll do better if you research area property taxes, homeowners insurance, association dues, upkeep, and other basic homeownership costs and add them to your estimated mortgage payments. You might also consider the impact of changing neighborhoods on other costs, like transportation or daycare.
Don't forget that you also need to allocate income to pay utilities, buy groceries, and save for retirement and emergencies. Obviously, you will still want to have some money left from your paycheck to have some fun.
Even though you may have to spend some time evaluating your financial situation and really thinking about what you value you the most, you will be better off if you have enough information to make a truly prudent decision.
In the end, you, other people with similar financial situations, and the mortgage company may not arrive at the same conclusions about exactly what an affordable mortgage means. You could benefit yourself and your family when you purchase a home because you have a chance to free yourself from landlords and start investing in your future.
On the other hand, lots of people have regretted making themselves "house poor" but rarely regretted planning for affordability.
If you think you might be ready to buy a house, talk with one of our mortgage advisors about what you qualify for, and find out how much you can comfortably afford.