How Much House Can I Afford
The smart way to buying a home.
I get asked this question a lot from people looking to buy their first home. How do I know how much house I can afford? There are really only two answers to this question. The more conservative answer is how much per month are you comfortable with paying. This is assuming you are keeping track of your budget monthly to get an idea of your comfort level. I say conservative because most people may not be comfortable with the second answer.
The second answer is given by the mortgage lender. They will determine how much they confidently think you can pay per month based on, guess what, your current budget.
Let’s tackle both answers here.
How much are you comfortable spending per month?
This one can be easy if you are currently budgeting or willing to do so for the next few months. This will give you a good gut check on how much you can afford to spend per month. You need to ask yourself, how much do you save per month? How much of that savings can you give up to pay for the cost of owning a house? If you are currently renting, remove the amount of your rental as it will be part of homeownership. Do not forget to include costs such as property taxes, association fees, utility bills, etc. This is what I did before buying my first condo. Not only was it a good gut check, but it gave me confidence in my ability to pay for the condo.
How the bank does it.
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Banks do not give approval based on gut feeling or how comfortable you are with the monthly payment. They go by numbers. Now this varies slightly depending on factors such as jobs, credit scores, etc. The first rule is the rule of 28.
Rule of 28
This is the standard rule they will use. The rule of 28 states that your monthly mortgage payment should not exceed 28% of your gross monthly income. So let’s say your income is $60,000 a year. You should not have a monthly mortgage payment of more than $1,400 a month..
Rule of 32
The rule of 32 is essentially the rule of 28 plus all your other housing payments. Things such as PMI, association fees, property taxes. Combining those other payments with your mortgage should not exceed 32% of your monthly gross income.
Rule of 40
The rule of 40 is the combination of the rule of 32 plus any other additional expenses you may have to spend per month. So we are talking student loans, car payments, credit card payments, alimony, and anything else you have to pay. All of this combined should not exceed 40% of your gross monthly income.
How much can you put for a down payment
Another factor besides income is how much you have saved up for a down payment. Conventional wisdom says you should put down 20% of the cost of the house. The reason for that is because this will remove PMI which is essentially mortgage insurance for the lender. The fee is usually .5% to 1% of the total loan amount per month for about 2 years. There are times when having a PMI makes sense. Sometimes the interest rate is so low that you are better off investing the money elsewhere. Sometimes you get a lower rate if you have a PMI. It is really a math problem. There are a lot of calculators online to show you how much you will pay overall for the lifetime of the loan. Spend a few minutes messing around with these calculators because they can save you thousands of dollars.
