How Much House Can I Afford?
How much house can I afford? Whether you are buying your first home, hoping to trade up to a larger one or even planning to downsize, this is probably a question you’re asking yourself.
If you are planning on paying cash, then the answer should be fairly straightforward. But if you need to get a home loan, then you’ll have to understand not only how much you think you can afford, but how much lenders think you can afford. Fortunately, there are some fairly easy formulas that can help you figure this out.
What’s in a Mortgage Payment?
A mortgage payment is typically made up of four parts:
Principal: This portion of your payment is the amount that goes toward paying off the amount you borrowed.
Interest: This is the portion of your payment that goes to the lender in the form of interest.
Taxes: Most lenders will want you to “escrow” your taxes. With each monthly payment, a portion of it will be set aside to pay your taxes when they come due. The lender then pays your taxes.
Insurance: Similarly, your lender may include in your payment funds to cover your estimated homeowners or property insurance. When that bill comes due, they will pay it.
Together, these four items make up what’s referred to as “PITI.” You probably simply know it is as your monthly mortgage payment.
Note that if you get a fixed-rate, fixed-term loan, the first portion of your payment – principal and interest – will be the same total amount each month. But if your payment includes taxes and insurance, then each year your lender will review your account and adjust that portion of your payment if there is a shortage or if they have withheld too much.
Know Your Numbers
PITI is important because a lender will compare that payment to your income to help determine how much you can afford to borrow. While various loan programs will have different specific requirements, generally your total monthly debt payments - including PITI - should be 45% or less of your monthly income. In addition to your mortgage payment, you may also have credit card payments, auto loans, student loans or other debts. If you do, add up the minimum monthly payment on each of those debts and add it to your estimated monthly mortgage payment to get your total monthly debt payments. (Don’t include credit cards you pay in full each month, or your current mortgage if you will be paying it off when you sell your home or refinance the loan.)
Here’s another simple way to look at it. Take your gross monthly income (that’s income before taxes are taken out) and multiply it by 45% – or .45 on your calculator. Then subtract your minimum monthly payments on any of your consumer debts. What’s left is the amount you generally can “afford” for a mortgage payment.
Or simply use our handy calculator above.
Keep in mind, the better your credit score, the lower the interest rate you should be able to get. A lower interest rate means a lower monthly payment. So the more you can do to build strong credit before you buy, the more you’ll be able to comfortably borrow. Ideally, you will want to get your free credit report from all three bureaus at least three or four months before you are ready to start home shopping, as that will give you plenty of time to fix mistakes if you find them. It’s also helpful to get your free credit score so you have an idea of where you stand.