Curling up on the couch with your laptop and looking through home listings can be fun. But when you’re serious about purchasing your first home, things can get complicated. That cute 1,300-square-foot Cape Cod is listed at $320,000, and across town there’s a four-bedroom Colonial with an asking price of $625,000. You like them both but wonder, how much house can I afford?
While searching for answers, you’ll probably come across the “28%-36% rule” or the “43% rule.” You’ll also learn about house affordability calculators that help you factor in variables to estimate what you can afford. And finally, you can talk to lenders and loan officers about options and resources. Here's how the options work and some of the pros and cons.
How Spreadsheets Can Help – or Miss the Mark – for Home Affordability
You could create your own spreadsheet with some simple inputs — asking price and down payment (a percentage or a dollar amount) — and calculate your potential interest and principal payment on a mortgage.
But that option carries two pitfalls, cautions Ashley Moore, a JP Morgan Chase vice president and lending manager based in Houston. For one, most people “making their own Excel spreadsheets may not have their ideas quite aligned with what lenders look at,” Moore says. And first-time home buyers may not know all the items they’ll have to cover at closing and monthly payments.
Luckily, many lenders, including Chase, have a house affordability calculator on their websites. That can be a great option, but you should understand a few things before jumping in.
Percentage Guidelines to Figure How Much House You Can Afford
Lenders consider the 28%-36% rule and the 43% rule to be guidelines more than hard-and-fast requirements. “Many financial advisers will tell you that anywhere between 25% and 28% of your monthly income is what you should spend on housing,” Moore says. For example, if you bring home $4,000 per month, and multiply that by 28%, you could afford a monthly mortgage payment of about $1,100. “Others say, maybe you look at the front-end ratio, with the housing expense being 28% of your gross income, and then 36% is the back end — your total debt service, including the housing costs,” Moore adds. This is known as your debt-to-income, or DTI, ratio.
Many lenders look for a DTI of up to 43%. In fact, for a mortgage to be eligible to be guaranteed by Freddie Mac, Fannie Mae, FHA, the VA, or USDA, borrowers must have a monthly DTI of 43% or less.
In addition to income and DTI, mortgage lenders consider your credit history and credit score: The higher the better for creditworthiness. “You might enjoy more favorable loan terms or a get a better interest rate,” Moore says. They are also interested in your cash on hand, your savings, and your down payment money.
When you calculate affordability, factor in that your monthly outlay is more than just mortgage payments. Your monthly payment should be low enough that you “can still continue to live the lifestyle you’d like to live,” says Carly Napier, REALTOR® and full-service agent with Elysian Homes in Rochester, N.Y. Allow for expenses such as student loan payments, entertainment, groceries, car payments, credit card debt, and, yes, savings.
House Affordability Calculators Help You Factor in Variables
With basic house affordability calculators, you'll be “entering your purchase price, monthly payment, or your monthly income that you want to stay within, how much you're going to put down,” Moore says. Calculator information is “based on the property and the current market. It may not take into consideration your income and your debt.”
House affordability calculators let you figure how much house you can afford based on factors such as:
Down Payment, Taxes, Insurance, and Climate
“You can tell the calculator to be flexible with down payment. You can look at the taxes and the insurance of a particular neighborhood,” Moore says. You can even factor in climate change, which has increased the number and severity of floods, with more areas considered high risk. Flood insurance might be required or a strong option.
Overlooked Fees
Other house affordability calculators may consider items first-time home buyers often overlook, such as bank fees, attorney fees, settlement fees, title insurance, recording fees, appraisal fees, and homeowners association fees. You need to have enough funding to pay for these items. “Some calculators suggest that about 3% to 5% of a home’s purchase price needs to be saved for additional closing costs,” Moore says. It may be possible to roll some of these items into the mortgage or get seller concessions, where the seller covers those fees for the buyer.
Repairs and Maintenance
You also need some money on hand for “repairs and maintenance. You have to assume things will go wrong, especially in many competitive markets where, unfortunately, waiving home inspections is commonplace,” Napier says.
Potential to Tap into Home Equity
Another option is a home value estimator, which can help you see the estimated value of a home you’re looking to buy. “If you are already a homeowner, this kind of calculator can help you figure out whether you can tap into your home equity to pay off debt or liabilities or upgrade your home,” Moore says.
Keep in mind that a house affordability calculator “is a compass, not a GPS,” Moore says. “It’s a great way to start, especially if you’re at the beginning stages of looking. Maybe you want to buy a house in two years. An affordability calculator is not a crystal ball. It is just giving you estimates.”
Get Expert Help to Find Out How Much House You Can Afford
“Many people hear the words ‘mortgage calculator,’ and they think that relates to their own situation, but a mortgage is [like] a fingerprint. There are no two that are the same,” Moore says. Lenders have many programs and products to help first-time home buyers.
It’s a good idea to go to a lender or loan officer early in your home buying journey. Napier says iif buyers come to her first, she connects them with a loan officer she considers “a trusted adviser. They are available to answer all their questions and to serve as extra counsel during what can be a stressful time."
A lender will know the options to help first-time home buyers. For example, “Chase has a $5,000 home buyer grant available in about 15,000 markets,” Moore says. “The grant is located in minority census tracts and allows individuals to use the money toward a down payment.”
Assistance programs are available to help self-employed individuals gain buying power or to provide loans for physicians, who often have considerable debt burdens. Napier suggests finding out about local home buyer grants such as the City of Rochester’s Home Purchase Assistance Program in her metro area. Lenders will have these details at their fingertips.
While all this information may seem daunting, help is available. You can start with a real estate agent for lender information. Every bank has a loan officer. Let them know you’re a first-time buyer and ask what you should look out for. With expert help, you can get the guidance you need to make an informed decision.