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You’ve worked hard toward your dream of owning a home, scrimped and saved for a down payment, and the time to shop for a place to call your own has finally arrived.
A home is no small purchase, and as you scroll through the listings in your area you start to wonder — how much house can I really afford?
That answer depends on several things, from your annual income to the size of your down payment, and the amount of debt you currently carry.
To figure out how much house you can afford, follow these steps to determine a comfortable budget. You can also check out HomeLight’s affordability calculator, which can help you settle on a price range that works for you.
Step 1: Evaluate your situation
The first step toward determining how much house you can afford is to take a close look at how much income you earn.
Consider whether you’re employed full-time or part-time and whether that’s likely to change in the future. Do you have other income, such as a side hustle or rental property, that contributes to your annual income? Are you the recipient of alimony or child support? All of these factors will determine what you can afford.
Likewise, you’ll need to take a look at your expenses. Add up your bills, plus any other debts or payments you’re responsible for, to get a feel for how much of your monthly budget is already spoken for. You’ll need to consider your day-to-day living expenses as well, like the money you spend on groceries and gas, so that you can budget for those, too.
Your credit score also plays a part in determining how much you can afford. A good credit score demonstrates to lenders that you’re likely to pay your bills in full and on time. Therefore, the better your credit score, the lower your interest rate will be — and the lower your interest rate, the smaller your monthly payments will be.
Keep in mind that what you think you can afford and what a mortgage lender is willing to loan you to buy a home doesn’t always match up. That’s because your lender is looking at what you pay in debts each month relative to your income.
“You may think you can afford a certain amount, but a lender looks at certain formulas like your debt-to income-ratio, your employment, and your credit history,” says Sherry Ludecker, a top-selling real estate agent in Johnson City, Tennessee, who specializes in helping first-time homebuyers. Each of those things impacts the amount of money a lender is willing to fork over to a buyer. “You should really be talking to a mortgage lender before you are looking at houses to make sure you are in the right ballpark.”
In 2019, the typical buyer financed 88% of their home price, putting down 12% of the home’s price as a down payment. You’ll need to consider how much money you have saved up and how much of your savings you plan to spend on the down payment and closing costs; both play a part in the home you’ll ultimately be able to afford.
Step 2: Think ahead
You might be buying a house to live in today, but before you settle on a budget, consider what your life might look like three to five years from now.
Might you ditch your side hustle or reduce your hours at work? Do you plan on having children soon, and will you or your partner stay home to care for them? Or will you send them to daycare — and how much does that cost?
Plan your budget with the long term in mind so you don’t find yourself in over your head down the road.
Step 3: See what’s possible
Now that you’ve got a good idea of your monthly budget and its potential to change in the future, it’s time to see what your financing options are.
“Start by talking with a mortgage lender or your bank before you make assumptions about what you’ll qualify for and what you can afford,” advises Ludecker.
“If you don’t have a great lender in mind, your real estate agent can give you some trustworthy options.”
Once you connect with a good lender, find out what your loan options are. Some loans like FHA loans, USDA loans, or VA loans allow you to purchase a home with a low down payment (3.5% down for FHA and 0% down for USDA or VA), but with a few caveats.
For example, borrowers with FHA loans who put down less than 20% must pay mortgage insurance. An FHA loan can require mortgage insurance for the lifetime of the mortgage if you put down less than 10% when you buy the house.
Next, determine what kind of interest rate you will get. If your credit score is low, you’ll be offered a higher interest rate.
What’s considered a low credit score? According to Bank of America, lenders generally consider 670 or above to be a good credit score. If your credit score is lower than 620, you may have a hard time getting a mortgage. In that case, you might want to ask your lender if it would be worth waiting a few months while you work to improve your credit so you can get a better interest rate.
Consider, too, that 15- or 20-year mortgages will come with lower interest rates than the standard 30-year mortgage. For example, a $300,000, 30-year mortgage might be available at a 4% interest rate while a 15-year mortgage for the same amount would have a 3.25% interest rate.
Step 4: Evaluate housing
The next step in determining how much home you can really afford is to take a look at how much homes cost in the area where you want to buy. Remember that in addition to the purchase price of the home, you’ll also pay property taxes and homeowner’s insurance with your mortgage — and mortgage insurance, too, if you’re putting down less than 20%.
If the neighborhood that you’re interested in has a homeowner’s association (HOA), as more than 40 million households do, be aware that HOA fees can run you from a few hundred dollars a year to a few hundred dollars every month. Keep in mind, too, that if you’re looking at a home with an HOA, lenders will include the HOA fees in their assessment of how much home they think you can afford to buy.
Finally, consider how much money you will put down on your home. If you put less than 20% down, you’ll likely have to pay mortgage insurance, which is calculated as a percentage of the loan amount.
“Get with your licensed agent who can speak to additional expenses you might expect in your area,” says Ludecker.
In addition to the ongoing costs of paying for and insuring a home, there are one-time costs to consider.
“A buyer should definitely budget for a home inspection and any other inspections that aren’t being paid for by the seller.” Those might include termite inspections, septic inspections, or HVAC inspections, Ludecker says.
Step 5: Determine your maximum comfortable monthly mortgage payment …
Before you begin house hunting, you’ll need to know the maximum amount you’ll want to pay for a mortgage every month, including taxes, insurance, and interest.
“Some people don’t want to spend everything they could spend,” says Ludecker. “Talk to a trusted financial adviser about how the mortgage payment would work within your monthly budget.”
Step 6: …Then work backward from there
Though you might get pre-approved for an eye-popping amount of money, you probably don’t want to shop at the very top of your price range or approval amount. If you do, you risk becoming house poor down the line.
Ludecker says that she has had deals die because a buyer begins shopping for homes in the range that they are pre-approved for, but when they sit down and crunch the numbers, they learn they don’t want that kind of payment every month.
“Address the mortgage payment early in the process so nobody spins their wheels and wastes time and emotional energy,” she advises.
As a final tip, Ludecker also points out that when buyers are in the process of shopping for a home they should not go out and make any other large purchases — like cars or furniture — because doing so might change their financial situation and jeopardize their lending.
“If you start buying furniture for a home you haven’t bought yet, you may not qualify for the same amount of money,” she warns.
“You don’t want to change your financial picture before closing day. Be consistent and careful during the buying process.”
Follow these steps, and you’ll be able to determine how much house you can really afford before you start shopping — ensuring you find the house of your dreams that’s also within your budget.
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