How Do You Know How Much House You Can Afford?

Buying your first home is one of life’s biggest milestones you’ll ever experience – and probably one of the largest purchases you’ll ever make. It’s exciting – but also nerve-wracking and potentially overwhelming if you’re a first-time buyer. 

One of the biggest questions that may be occupying most of your thoughts right now is: “How much house can I actually afford?” Well, there are some tried-and-true ways to figure it out, without losing sleep over the fear of monthly payments! 

Consider this your friendly guide to home-buying that can help take away all the uncertainties: Let’s break it all down in 7 quick steps so you can buy your dream home with confidence – and without financial regrets later.

Step 1: Know Your Monthly Budget (And Stick to It!)

The first step is understanding your finances inside and out. Here’s how:

• Calculate Your Monthly Income: Start by figuring out how much money you bring home each month after taxes. This is your net income, and it’s the foundation of all your budgeting.
• Track Your Expenses: Take an honest look at your current spending. List out all fixed expenses (rent, utilities, car payments and insurance) and variable expenses (groceries, entertainment and dining out). Don’t forget savings, retirement contributions or payment for credit cards and other loans.
• Understand Your Debt-to-Income (DTI) Ratio: You calculate your DTI by taking your total monthly debts (financial output) by your gross monthly income (financial input). For example, if your total debt expenditure (car loan, student loans, etc.) is $1,000 per month and your gross income is $5,000, your DTI is 20%. Most conventional lenders prefer a DTI of 36% or lower for “prime” loans with the lowest interest rates, but many lenders will still approve loans with DTIs that are much higher.

If your DTI is somewhat high, you may want to take a while to focus on paying down your debt before buying a home. This will not only improve your odds of getting approved for a mortgage but also get you a better interest rate – which translates to thousands of dollars worth of savings over the years. 

Step 2: Save for the Down Payment

Your down payment plays a huge role in determining how much house you can afford, so if it isn’t time to “pull the trigger” on a mortgage, you can use this time to cull your discretionary spending so that you increase your savings for that all-important down payment. 

In general:

• A Standard Down Payment: This is usually 20% of the home’s purchase price (to avoid private mortgage insurance or PMI) and generally makes it easier to find a lender.
• Low-Down-Payment Loans: FHA loans require as little as 3.5%, while conventional loans may allow 3%-5% down. Some VA loans require no down payment at all.

Why does the downpayment matter so much if you can get a loan with as little as 3% down? Well, the more money you put down upfront, the smaller your loan will be – and the more affordable your monthly payments will feel. So, just because you can get a loan with 3% down and you have $12,000 saved, that doesn’t necessarily mean that you can comfortably afford a $400,000 home.

Step 3: Factor in Closing Costs

When calculating your home budget, don’t forget about closing costs! These typically run between 2% and 5% of the home’s purchase price and include fees for:

• Appraisals
• Home inspections
• Title insurance
• Loan origination fees
• Taxes and prepaid insurance

For a $300,000 home, expect to pay an additional $6,000 to $15,000 in closing costs. In some cases, these can be shared with the seller or rolled into your loan – but that’s not always possible. And, rolling those into your loan also means that you’ll have a bigger mortgage.

Step 4: Budget for Ongoing Homeownership Costs

Buying the house is just the start. Make sure you account for ongoing expenses like:

• Property Taxes: These vary by location but can add thousands to your annual costs.
• Homeowner’s Insurance: Required by lenders, this covers damage to your home and belongings.
• HOA Fees: If your neighborhood has a homeowner’s association, expect some hefty monthly dues. Make sure you understand how those will affect your overall budget.
• Maintenance and Repairs: Budget at least 1% of your home’s value per year for routine maintenance (and save extra for unexpected repairs).
• Utilities: Heating, cooling, water and electricity bills may be higher than what you’re used to paying as a renter.

While no crystal ball will allow you to plan for every eventuality, you can make some reasonable estimates and factor those into your overall costs.

Step 5: Use Mortgage Calculators for Real-World Numbers

Online mortgage calculators are available on many finance sites, and they’re a great way to get an idea of what your monthly mortgage payments will be. Just enter the loan amount, the interest rate you think you’ll get based on your credit history and the loan term you want (usually 15 or 30 years) to estimate your principal and interest payments. Don’t forget to add in property insurance and taxes for a solid estimate!

Step 6: Give the Estimated Budget a Test

One great way to prepare for homeownership is to test-drive your new budget before you buy. For a few months, set aside the difference between your current rent and your projected mortgage payment, along with estimated maintenance and utility costs.

• If it feels manageable: You’re in good shape!
• If it feels tight: Consider adjusting your price range or building more savings before buying.

Step 7: Get Pre-Approved for a Mortgage

Once you’ve crunched the numbers and saved for a down payment, it’s time to get pre-approved – which is a fairly definitive way to learn what sort of bet a lender will make on you. Pre-approval is a lender’s approximation of how much you can borrow from them based on your:

• Income
• Credit score
• Debt-to-income ratio
• Down payment

It’s important to note that pre-approval is much more involved than pre-qualification. A pre-qualification is a lender’s “best guess” based on the information you give them. A pre-approval is a tentative commitment. 

It’s also wise to remember that just because a lender approves you for a certain amount doesn’t mean you should spend the full amount. Always prioritize your financial comfort over maxing out your budget.

Final Thoughts: What to Remember Before You Buy

Ultimately, the goal isn’t just to buy a house – it’s to buy a home that fits your lifestyle and budget without turning your dream into a financial nightmare. It’s critical to know your numbers, and plan for the unexpected –  and then you’ll feel confident moving into the next phase of your life!