Knowing what you can afford is one of the first things you’ll need to figure out if you’re thinking about buying a house. The best way to find out how much house you can afford is by getting pre-approved with a mortgage lender. The lender’s loan officer will be trained to ask you the right questions to get the most accurate picture of your financial health.
The following are the same factors a loan officer will use to calculate your home price budget. Your situation is likely unique, so now’s a great time to chat with a loan officer. Putting all the pieces together yourself can be overwhelming, and it’s their job to complete the puzzle.
Factors that impact your pre-approval
These are the numbers loan officers look at to determine your maximum home price, or the amount the lender is willing to loan you to purchase a home. Each of these factors have a direct effect on your loan pre-approval, but don’t overthink these! It’s your lender’s job to calculate everything, and you won’t know how much you can spend until you actually meet with them.
Your income will be the basis for the kind of house you can afford, and you should have at least two years of stable income history. Combine your income with your partner’s or co-borrower’s and don’t forget to add up all sources of income. This figure should include base salary, commissions, bonuses, overtime, tips, rental income, investment income, alimony, child support, etc, all before taxes are taken out.
Your available funds are the cash you have in the bank and your investments. This is meant to cover your down payment and closing costs, and some lenders prefer it if you still have cash reserves after paying all costs.
Include all of your and your co-borrower’s monthly debts, including: minimum monthly required credit card payments, car payments, student loans, alimony/child support payments, mortgage payments that will remain after you purchase your new home (if you’re already a homeowner), and other personal loans with periodic payments. It doesn’t include credit card balances you pay off in full each month, existing house payments that will become obsolete once you buy a new home or the new mortgage you are seeking.
Your lender will use a figure called DTI, or debt-to-income ratio, which tells them how much debt you have compared to how much you make monthly. A high DTI means you have too much debt for your income, and a low DTI is preferred for getting the best mortgage rate. Lenders are generally looking for less than 43% DTI, but the lower, the better.
A great credit score can help lenders feel more confident about your ability to pay back your mortgage. That being said, a fair or good score doesn’t necessarily prevent you from receiving a mortgage. Higher credit scores usually get lower interest rates, so it’s a good idea to work on your credit if it’s under 650.
Other factors you should think about
These are factors that don’t necessarily impact your loan amount, but that you should consider when thinking about the cost of your new home. What you can technically afford might not be the same as what’s smart to spend.
Do you eat out a lot? Splurge on nice salons? Are you a big spender or do you save every penny? Everyone spends and saves money differently. If you know a lot of your income goes to lifestyle expenses, then it might be a good idea to buy a house with a slightly smaller mortgage payment than what you can afford with your income. Unless you’re ready to make some major lifestyle changes, be honest with yourself about the money you spend.
Getting married, having a baby, starting a business–these are all things that take good savings and a healthy budget. If you know you’re going to have major changes to your spending in the next 5 years, make sure you factor that into your homebuying decision. If you’re about to have a child, it might not be a good idea to purchase at the max price you’re approved for.
Everyone’s risk tolerance and risk aversion are different. Some will want to spend the absolute least they can and sacrifice on location, home quality, and space to keep a solid financial cushion. Others will be willing to spend quite a bit more on their home purchase. It’s completely up to you, and both choices require sacrifices to some extent. Ask yourself these questions and, again, always be honest with yourself about what you need and want.
- What are my non-negotiables in a home?
- What house features am I willing to sacrifice?
- Am I willing to go over my budget if I find the perfect house?
- Am I willing to go under budget and do some renovating?
So, exactly how much house can I afford?
Getting pre-approved with a loan officer is really the only way to know exactly how much the bank is willing to loan you, though there are some great tools that provide a rough estimate of your maximum home price.
An affordability calculator will use your income, monthly debts, and down payment savings to figure out your potential mortgage amount, and you can also play with interest rates, loan terms, and property tax amounts to get an even better estimate.
If you just want to do the napkin math for now to get a rough figure, this article provides a great example and walks you through some calculations.
Once you have a good idea of what you can afford, make sure you gather up your documents and get pre-approved. It’s easy, free, and there’s absolutely no commitment.
Dealing with the financials isn’t the most fun part of buying a house, but you’ll be glad to know your budget before you start looking. Happy house-hunting!