If you’re asking yourself how much home you can afford before you buy a new house, you’re already ahead of the curve. By figuring out how much you can afford for a house, you ensure that you don’t overestimate your ability to make payments. Additionally, you’ll save time by only looking at homes that are within your budget.
Based on your own unique scenario, what you can afford for a home may be less or more. The rest of this post will show you how.
How Much Home Can You Afford? Depends on The Mortgage
While you may have a gut feeling about how much you can afford for monthly payments, mortgage lenders have a specific method that they use to calculate how much they’re willing to lend you. So to answer this question, you’ll have to look at it from a lender’s perspective.
First, you’ll need to determine how much of a mortgage payment you can afford each month. (Note that you may want to consider monthly tax and insurance payments as well.) Then, knowing that number, you can determine the loan amount you’ll be able to afford—and voila, you’ll know how much housing you can afford.
Here’s how to do this:
1) Calculate Your Maximum Debt Payment
The first thing to do is determine how much of a maximum debt payment you can afford, based on your income. To do this, you’ll need to know your gross income and then take into consideration the lender’s DTI requirements.
Your gross income is how much you make before paying taxes and other deductions, such as retirement contributions and health insurance.
DTI is your debt-to-income ratio. Every lender has different DTI requirements for their mortgage loans, but generally speaking, the most common DTI is 36%.
|Your monthly gross income:||$6,000|
|Lender’s maximum DTI limit:||36%|
|Multiply gross income by DTI:||$6,000 x 0.36 = $2,160|
|Your maximum debt payment:||$2,160|
Based on the calculation above, you can afford a maximum of $2,160 toward your mortgage loan payments each month, assuming you have no other debt obligations. If you do have other debt obligations—such as car payments, credit card payments, student loan payments, etc.—then it’s important to note that your total DTI ratio also includes all of those additional payments.
In this example, what you would pay toward PITI (principal, interest, taxes, insurance) and other debt payments would need to not exceed $2,160.
2) Calculate Your PITI
PITI represents your total housing payments that you make each month, and tells your lender how much of your monthly income will be used to maintain payments for your mortgage, taxes, and homeowner’s insurance.
PITI Monthly Payments = Loan Principle + Loan Interest + Property Taxes + Homeowner’s Insurance
To calculate your PITI, you need to subtract the other debt payments that you’re required to make each month from your maximum debt payment ratio (DTI), which we calculated earlier.
These other debt payments include your car payment, credit card payment, student loan payment, alimony/child support, and other similar debt commitments. Do not include monthly payments such as cell phone bills, childcare, or auto insurance.
Here’s how to calculate your PITI:
|Your maximum debt payment allowable:||$2,160|
|Determine total monthly debt payments:|
(Car + Personal Loan + Student Loan, etc.)
|$200 + $100 + $50 = $350|
|Subtract debt payments from maximum debt payment:||$2,160 – $350 = $1,810|
|Your maximum PITI payment:||$1,810|
3) Calculate Your House Affordability Based on Your PITI
Now that you know your PITI payment, you can calculate how much of a house you can afford by determining how much mortgage you can afford.
If you care to know, here’s how the house affordability calculator works:
Once you know your maximum PITI, you’ll need to accurately determine your principal, interest, taxes and insurance. To do this, you’ll need to know the loan terms that you’re being offered, such as your interest rate and the length of your loan commitment.
Next, you’ll need to determine your insurance and property tax. Your insurance is easy as getting a quote from a homeowner’s insurance company and dividing that number by 12 months. However, your property tax is really tricky to figure out since property taxes are a percentage of the value of the home you’re buying, but you don’t know how much of a house you can afford yet! Let’s see how you can calculate your estimated property tax payments below.
With a $6,000/Month Income, You Can Afford Approximately $302,498
If you make $6,000 in gross income per month at a 36% DTI ratio, your maximum affordable debt payment is $2,160. Then, backing out $350 in other debt payments, your maximum mortgage PITI payment is $1,810. Based on a 30-year fixed mortgage at a 4.5% interest rate, with 1.1% in estimated annual property taxes, you’ll be able to afford a mortgage loan amount of $302,498.
Don’t Take on a Mortgage You Can’t Afford
Understanding how much house you can afford is the responsible thing to do. Knowing you’ll be able to afford your monthly mortgage ensures that you won’t get yourself into financial trouble and default on your payments. Having that peace of mind makes buying your first home or upgrading to a new home a pleasant and exciting experience.