Budgeting: How Much House Can You Afford?
Budgeting is essential as you begin to think about buying a house. Although your lender can help you determine how much house you can afford, you can get an idea on your own. Doing so will help you be realistic as well as determine how much you need to save for down payments and closing costs.
Here are three simple rules for budgeting to determine how much house you can afford.
Rule of 28
This rule will help you determine your maximum mortgage payment. Essentially, this rule states that your mortgage payment should not be greater than 28% of your gross monthly income. For example, if your income before taxes is $75,000, then you should not have a payment that is more than $1750. (($75,000 x 0.28)/12 = $1,750)
Rule of 32
This rule takes into account your mortgage payment as well as the rest of your housing costs. These additional costs include:
- Mortgage
- Homeowner’s insurance
- Property taxes
- Private mortgage insurance (PMI), if applicable
- Homeowner’s association fees, if applicable
The total housing payment should not exceed more than 32% of your gross monthly income. So, in the same example from above, when budgeting, your total housing would not be able to exceed $2,000 (($75,000 x 0.32)/12 = $2,000).
Rule of 40
This rule takes into account your debt payments, which includes your mortgage plus:
- Student loans
- Auto loans
- Personal loans
- Credit card payments
The total amount of debt should not be more than 40% of your gross monthly income. With this rule, large debts in other areas keep your mortgage debt at a lower threshold. Once again, using the same example, your debts should not be more than $2,500 per month (($75,000 x 0.40)/12 = $2,500).
Calculating Mortgage
The best way to calculate the mortgage is to know the exact amount you will borrow at the exact interest rate. However, as you try to think about budgeting for future plans, you can estimate your mortgage based on this calculation:
For every $100,000 borrowed at 4%, you can expect mortgage payments to be $500.
Back to our example of making $75,000 per year, the Rule of 28 says you can afford a $1,750 mortgage payment. The maximum mortgage amount you can afford would then follow this equation:
(Rule of 28/$500) x $100,000 = Maximum Mortgage Amount
In our example, ($1750/500) x $100,000 = $350,000.
Add the Down Payment
Now that you know the maximum mortgage, you can determine the maximum asking price by adding in your down payment. If you make a 20% down payment, the highest price would be $420,000 ($350,000 + $70,000).
It is possible to make a lower down payment, like 10%, making the highest price you can afford be $385,000. However, keep in mind that many loans with less than 20% down also require private mortgage insurance, which will decrease how much house you can afford.
Of course, these are just approximations to help you determine your potential budgeting and savings needs. When you are ready to look for a new home, contact us. We can provide you a list of local preferred lenders and then help you find the home of your dreams.