How Much Home Can I Afford?

    When we talk about how much house we can afford, we are really talking about how much money we can afford to spend on a mortgage payment each month.

    How Much Home Can I Afford?

    If you’ve ever even thought about buying a home, “how much house can I afford” is probably the first question you asked yourself. Asking questions like this is an important part of becoming a responsible home shopper.

    And the answer to this question may surprise you.

    Few people can “afford” to write a $200,000 check to buy a house, but many can easily make the payment on a $200,000 mortgage. In reality, when buying a home, most people are buying a payment. Focusing on a payment instead of a purchase price will protect you from payment shock when you discover that you’ve been shopping in the wrong price range.

    Maybe you’re just getting started. You’ve thought about one day buying a house and aren’t sure where to start. Or maybe you’ve been working hard to save for a down payment, you’re getting closer to your goal, and it’s time to find your new home. It doesn’t matter where you are in the process. Having a reasonable idea of what you can pay for your new home is essential.

    What does afford even mean?

    “Afford” is rather subjective when it comes to buying a house, which is to say it probably means something a little bit different for everyone. Most of us will need a mortgage to buy a home. When we talk about how much house we can afford, we are really talking about how much money we can afford to spend on a mortgage payment each month.

    It’s important for us to look at home affordability this way for a couple of reasons:

    • Very few people can just write a check and buy their home outright.
    • Your payment is the actual dollar amount that will come out of your checking account every month. If you cannot make this payment or it inhibits you from paying other bills, you cannot afford it.

    Working backwards from a monthly payment to determine how much house you can afford

    Can I afford a $200,000 house?

    Can I afford a $300,000 house?

    These are the wrong questions. Depending on the house and its associated costs, the answer could be yes to the $300,000 house and no to the $200,000 house. We’ll look at a couple of scenarios later to help us understand why this is the case, but for now it is important to understand that you need  to determine what PAYMENT you can afford, not how much house.

    By working backwards from a comfortable payment, you ensure that you’ll  be able to pay your mortgage without stress every month. Let’s take this back a step further and explore, what, exactly,a mortgage payment consists of and how you can use the overall mortgage payment to determine how much house you can afford.

    What Makes Up a Mortgage Payment?

    In most cases your mortgage payment will consist of more than just the amount needed to pay down your loan balance plus interest. It may also include mortgage insurance (PMI or MIP), homeowner’s insurance, and property taxes. You may also have a homeowner’s association (HOA) to which you’ll pay dues. HOA dues are not included in the payment you’ll make to the bank holding your mortgage, but it is important to factor HOA dues into your housing budget.

    Payment Definitions

    Principal

    The principal piece of your payment is the actual amount applied to your loan balance that results in the balance decreasing over time. The amount paid to principal is relatively small in the beginning of your loan term. It increases gradually from month to month until your loan is paid in full.

    Interest

    You’ll pay interest on your loan based on the interest rate you obtained when you bought your house. Interest accrues daily based on your principal balance since your last payment. When you make your payment, the interest balance is paid to zero, and it begins accruing again until your next payment

    Mortgage Insurance (PMI or MIP)

    If you do not have a 20% down payment, you will most likely need mortgage insurance. Mortgage insurance protects the lender when taking on the additional risk of default by accepting a smaller down payment (less than 20%). There are different forms of MIP available depending on the loan type.

    Homeowner’s Insurance

    Your annual homeowner’s insurance will likely be divided into twelve payments and included in your mortgage payment. Most loan types and lenders providing government loans (FHA, VA, USDA) require this.

    Annual Property Taxes

    Like homeowner’s insurance, your property taxes are likely required to be paid through your mortgage payment. They are divided by twelve and paid monthly as part of your house payment.

    * If permitted by your lender, you may choose to pay your taxes and insurance annually outside of your mortgage payment. Regardless, you need to factor these costs into your budget when determining how much you can afford.

    Homeowner’s Association (HOA) Dues

    HOA dues are not part of your payment, but your lender will factor them in when determining if you qualify for a mortgage.

    So, how much house can you afford?

    Now that we know what’s in a mortgage payment, how do we use that to determine how much home we can afford? Let me break it down for you:

    1. What is the maximum amount I  want my monthly mortgage payment to be?
    2. How much are property taxes where I am buying?
    3. What is the typical homeowner’s insurance rate in my area?
    4. Is there a homeowner’s association in my new neighborhood?
    5. What is the maximum house price I can afford?

    It is important to understand we are attempting to determine what you can afford, not what you qualify for. These are two very different things. You may qualify for more than you can afford—don’t let that tempt you into buying more house than you can afford.

    1. What is the maximum amount I want my monthly mortgage payment to be?

    Only you know what you can comfortably pay each month given your lifestyle, other bills, spending habits, etc. There are, however, a few guideposts you can use to get started.

    First, if you are buying your first home, you are probably paying rent. Using your current rent payment as a guide is a good place to start. Are you comfortable paying a little more? A little less? Maybe your current rent is the most you want your house payment to be. Whatever the case, using what you are already paying for housing is a great benchmark.

    For example, if you currently have $1,000 left over each month to save, perhaps some of that can go towards your new house payment. If your rent is $1,200 per month, maybe you’ll be comfortable saving $700 a month instead of $1,000 and having a $1,500 mortgage payment. The point is to use your current situation to assess what payment amount is comfortable.

    2. How much are property taxes where I am buying?

    Property taxes vary widely from state to state, county to county, and even city to city. Most listing sites will display the property tax history for a given home, so this information should be readily available. If you don’t have a particular house in mind, you can use tools like taxrates.org to get a rough idea of what your property taxes might be.

    3. What is the typical homeowner’s insurance rate in my area?

    Homeowner’s insurance is required and can also vary depending on location. You likely have some sort of property insurance already (auto or renter policy). A quick phone call to your agent or insurance company should provide a general idea of what a typical premium might be given a general home price. Additionally, if you are working with a real estate agent, they should be able to give you a good idea of what to expect.

    4. Is There a homeowner’s association in my new neighborhood?

    Most listing sites will have HOA information. It is important to factor this in, especially when buying in communities with public areas such as pools and parks. HOA dues can be several hundred dollars per month depending on the services provided. Remember, this is not part of your actual house payment, but it will impact your total monthly housing expense.

    5. What is the maximum house price I can afford?

    Now the fun part. Once you have an idea of what all these future numbers might be, you can determine how much house you  can afford. Obviously, you’ll want to calculate the overall payment prices based on your desired monthly house payment. Our calculators will do the math. They provide inputs for the various parameters that allow you to pinpoint a purchase price while keeping the total mortgage payment plus HOA within your desired maximum payment.

    Calculating how much home you can afford works like this:

    Desired Maximum Mortgage Payment – Annual Property Taxes / 12 – Annual Homeowner’s Insurance / 12 – Monthly HOA Due = Maximum Principal, MIP, & Interest Payment

    Once we know our maximum principal and interest payment, it is as simple as playing around with various purchase prices, down payments, and interest rates to determine if our final payment meets our budget requirements.

    Example

    Your current rent payment is $1,000 per month. You save about $800 per month and want to use $300 of that towards your new home.

    Your desired house payment is $1,300.

    NOTE: Our calculators do the work for you, but it’s important to know what’s going on in order to fully grasp why you want to plan around a payment and not a purchase price.

    You’ve looked at a few homes online and determined your property taxes will be around $2,400 per year. We divide that by 12 for a monthly tax payment of $200.

    Your insurance agent is excited for you to buy your new home. She said for the area in which you are looking, expect to pay $600 to $900 per year. Using the high end, we expect to pay $75 per month for insurance.

    Most of the neighborhoods where you are looking to buy are well kept with nice common areas. They seem to average about $240 per year in association fees. That’s $20 per month.

    We can now subtract these estimates of the additional monthly costs of homeownership from our desired house payment to determine how much house we can afford.

    $1,300 – $200 – $75 – $20 = $1,005

    Our FHA, VA, and USDA loan calculators compute the mortgage insurance (MIP/PMI) and principal and interest payment for you, so all you’ll need to do is experiment with various purchase prices, interest rates, and terms to determine our purchase budget. Using our FHA loan calculator, you can see that a $200,000 purchase price with a $7,000 down payment and a 3.75% interest rate results in a $909.45 principal and interest payment and a $135.56 MIP payment, totaling $1,045.01. This is $40 above your goal. It’s up to you to decide if you’re comfortable with this payment.

    People often fall into the trap of assuming that they can easily afford a house, without considering things that could go wrong. In reality, a $200,000 house is probably at the very top of your budget. What happens if the house has an older wood-shake roof and the homeowner’s insurance premium increases to $1,500/year as a result? Now your mortgage payment is $50 more than you wanted to pay.

    Maybe you found a house with great schools and the property taxes are $4,800, twice as much as you’d estimated. That’s a $200 payment increase.

    The point in all of this is to focus on your monthly mortgage payment when you are shopping for a home. If you stick to a plan and commit to keeping your total payment under what is comfortable for you, you’ll save yourself from unnecessary stress, unexpected problems with your lender, and most importantly, you’ll be happy knowing you can afford your new home.