So much thought goes into buying a home. Location, amenities, size, school districts and other factors are likely on your mind. However, price might be the biggest and most important factor. Wondering how much house can I afford? Knowing this crucial information will help you start your home search off on the right foot.
Wondering how much house can I afford? Most experts suggest that home buyers budget 28% of their gross monthly income for housing costs. You can use this simple rule to get a general estimate and determine how much home you can afford. Keep in mind that other factors like your credit score, debt to income ratio and down payment also impact how much bang you can get for your buck.
Get out your calculator, take a hard look at your financial situation and get ready to determine how much house you can purchase. Being armed with this essential information will make shopping for home loans easier.
How Does the 28/36 Rule Impact How Much House Can I Afford?
Are you financially savvy? If so, you might know about the 28/36 rule. In the simplest terms, the 28/36 rule suggests that individuals and families should spend no more than 28% of their monthly income on housing and no more than 36% of their monthly income on total debt, including mortgage, car loans, student loans, credit cards and other debts.
The 28/36 rule might be considered the golden rule among mortgage lenders. Following the 28/36 rule will likely help you answer the question of “how much house can I afford?”
It is important to keep in mind that a lot more goes into determining housing costs than your monthly payment to the amount you borrowed from the bank. In the finance world, housing expenses are known as PITI: principal, interest, taxes and insurance.
- Principal: The loan’s principal is the amount borrowed. If you borrow $200,000 to purchase your home, your loan principal is $200,000. Loans are structured in a way that means the amount of your payment going toward the principal is low at the beginning, as more of your payment is going toward interest. As you get closer to the end of your loan, more of your payments go toward the initial amount borrowed.
- Interest: Interest is basically the reward the bank gets by taking a risk and loaning money to you. Your loan’s interest rate directly correlates to your monthly mortgage payment. If you have a high interest rate, you’ll likely have a higher mortgage payment.
- Taxes: Your local government assesses property taxes to pay for infrastructure and things like the police, fire department, libraries and other essential parts of your community.
- Insurance: You’ll likely pay insurance with each mortgage payment, then hold the money in escrow until it is due. As a homeowner, you’re on the hook for property insurance. Private mortgage insurance (PMI) might also be necessary. In most cases, you will only be required to pay PMI if you put less than 20% of your home’s selling price down at the time of closing.
Your 28% housing budget should include PITI. Other household expenses, like the cable bill and electric bill, aren’t included in the PITI calculation.
How Does the 28/36 Rule Apply to Me?
How does the 28% rule break down for the typical family? Let’s pull out a calculator and get ready to crunch the numbers.
The most recent U.S. census data indicates household income is $61,937. Following the 28% rule, this means the average U.S. family can spend $1,445 per month on PITI. This means the typical family might be able to pay $1,100 per month on principal and interest with their regular mortgage payment, with $345 per month set aside for insurance and property taxes.
With a standard 30-year mortgage at a 3.92% interest rate and $1,100 monthly principal and interest mortgage payment, this means the typical family might be able to borrow $232,649 for a home when following the 28/36 rule. This leaves the family with $413 to put toward other monthly debt, like car payments, student loans and credit cards under the 28/36 rule. If your total monthly debts are more than $413, you will likely be able to borrow less based on your debt to income ratio.
Following the 28/36 rule is a good way to stay financially sound. However, everyone’s situation is different. Working with a financial advisor of Certified Financial Planner can help you stay on track, manage debt and be ready to buy a house. While you’re at it, you can use an online mortgage calculator to help figure out how much house you can afford.
How Do Credit Scores Impact How Much House Can I Afford?
Your credit score is another determining factor when thinking about how much home you can afford. Basically, homebuyers with higher credit scores qualify for better mortgage rates than those with less-than-stellar scores. The amount of interest you pay can add up to thousands of dollars over the life of your loan and seriously impacts what you end up paying for your house.
Let’s take out our calculators again and look at how some of the numbers might work out for you based on your credit score.
According to information from MyFICO, 15-year fixed rates can majorly vary based on your credit rating. For example, if your credit rating is excellent (760-850 FICO score), you might pay 2.508% APR on a $200,000 mortgage. This adds up to $1,334 per month or $240,120 over the span of 180 payments over 15 years. If you have fair credit (620-639 FICO score), you might pay 4.097% APR on a $200,000 mortgage. This works out to be $1,489 per month or $268,020 over the span of 180 payments over 15 years.
As you can see, your interest rate can seriously impact your monthly payment and what you pay for your home over the life of the loan. Those with lower credit scores will have a harder time building equity in their home and might find they can afford less home than their peers with higher credit scores.
What Other Factors Influence How Much House Can I Afford?
Along with the 28/36 rule and your credit score, you’ll find a few other significant factors that can play a role in determining how much house you can afford.
Debt to Income Ratio
Your debt to income ratio (also known as DTI) does more than determine how much cash you have for PITI each month. In fact, your DTI is a significant part of your credit score and the interest rate you can get from a lender.
If you have a high DTI, getting a mortgage might be difficult. If you’re able to get a loan, the interest might cost an arm and a leg. If you have a low DTI, you might be eligible for a home loan with a desirable interest rate. Low DTI and a low interest rate means you can afford more house.
Down Payment Available
Most mortgage lenders want you to make a standard down payment of 20% when purchasing a home. This means if you’re taking out the $232,000 mortgage mentioned above, you might expect to put down $26,400 at closing. You also might be able to put down less with government loans and other special programs.
If you’re putting down a bigger down payment, the principal of your home loan will shrink. This will reduce the amount borrowed and keep your monthly payments lower and get you more hou
On the other hand, if you’re putting down a lower payment your principal will be larger and you’ll likely be on the hook for PMI each month.
Find a New Home Within Your Budget
How much house can I afford? Once you have a number narrowed down based on your individual financial situation, you can start working with a Realtor to find a new home within your budget.
Let Bill Blankenship, one of Ocala’s best Realtors, guide you on your home buying journey. Reach out today and start taking steps to move into your dream home with Bill on your side.
