Step 4: How much house can you afford?

What, Why, How Practice what you learned Check your understanding Do it yourself

What, Why, How

What determines my price range?

The amount you can afford to pay for a home depends on your income, the amount you must continue to pay on other debts, the amount of cash you have for the down payment and closing costs, and the interest rates available to you.

Lenders will want to know if your income is sufficient to pay your mortgage and other monthly debt payments. They are also interested in how much money you have for the down payment, closing costs and fees.

Why should I estimate a price range?

Homeownership is at an all-time high, with over 67% of Americans now owning their own homes. Perhaps you are ready to join them, but how much can you afford? It’s best not to begin your search for a home until you have answered that question. Ultimately, your price range will depend somewhat on the type of mortgage you choose, but even before you reach that decision you can estimate how much house you can afford. By estimating your price range, you will better understand the factors that determine whether your mortgage application will be approved or rejected.

How do credit scores affect you when applying for a loan?

Use Credit.com's Home Affordability Calculator to estimate how much home you can afford. The following example describes how it's done:

Joanne's Situation Joanne is thinking about buying a home. She has already created a budget and calculated that she has $60,000 for the down payment and closing costs. Her debt payments (a student loan payment of $200, a $140 car payment, and $160 for debt on her credit card) are $500 per month.

Monthly Income	$6,500
Other Debt (monthly)	$500
Cash Available for Down Payment + Closing Costs	$60,000

She found the following interest rates:

30 year fixed mortgage	6%
15 year fixed mortgage	5.5%

Joanne enters her monthly income, other debt, and the 6% interest rate into the calculator as shown below in Figure 1. She then selects “30 Years” for the loan term.

Figure 1: Home Affordability Calculator

Next, she clicks on the “Purchase Price Table” tab at the top of the calculator (see Figure 2 below). In the table she finds that her $60,000 cash available will cover a 20% down payment of $56,022 and estimated closing costs of $3,000. In the last column of the 20% row the calculator shows the Purchase Price that she can afford, $280,109.84.

This maximum purchase price is not set in stone. A lender will consider other factors and adjust the amount that you can borrow. However, this estimate is a good starting point that will give you an idea of your price range before you start shopping.

Figure 2: Home Affordability Calculator

Notice that the calculator shows “Front / Back Ratio 28.0% / 36.0%.” The 28% front ratio is the housing expense ratio. The 36% back ratio is the total expense ratio. This means that the calculator assumes that you can afford to spend 28% of your income on housing, and 36% of your income on housing + other debts. 28% and 36% are the ratios traditionally used by lenders to determine how much a borrower can afford. It is possible that a lender will adjust the amount you can borrow based on other factors.

“Maximum PITI” is the highest monthly housing payment that you can afford as an owner. PITI stands for Principle, Interest, Taxes, and Insurance. The calculator estimates annual taxes to be 1.25% and insurance to be 0.5% of the price of the home. The closing cost, ratio, tax, and insurance assumptions can be adjusted by clicking the “Other Loan Factors” tab and changing the values to match your actual situation.

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