How to Know How Much House You Can ACTUALLY Afford

Budgeting / By /
“How much house can I afford” is an awesome question potential homebuyers ask that is often redirected to “how much house will the bank QUALIFY me for?” The serious (and potentially bankruptcy-inducing) problem is that banks will qualify you for MUCH more than you can afford!
Yes, you may be able to make your mortgage payment and most of your necessities, but if you take on TOO LARGE of a mortgage loan, you will most likely NOT be:
– Saving enough money toward retirement
– Replenishing your emergency fund
– Saving for needed home updates, new cars, or other large savings goals or
– Have money left over for discretionary things like vacations, gifts, shopping, kids’ sports, music lessons, entertainment, haircuts, and birthday parties (aka LIVING).

How Much House Can I Afford

Why would Banks/Mortgage Brokers/Realtors want you to buy MORE than you can afford?

Disclaimer: All the realtors and mortgage brokers I know and have worked with are GOOD and moral people (our lovely realtors felt like family and I’d recommend them to anyone). That being said, homebuyers need to be aware that lenders (banks), mortgage brokers, and realtors are all incentivized for you to buy a more EXPENSIVE home (and therefore get a bigger mortgage loan).
Lenders allowing you to borrow more money and get a nicer home may seem like a shortcut for wealth but it’s actually the setup for turning the American Dream (of owning a home/land) into the American NIGHTMARE (of losing it all).
When you buy a more expensive home–everyone makes more money (except YOU):
– Both sellers’ and buyers’ Realtor agents earn more because commissions are based on the purchase price of the home.
– Mortgage lenders earn more in interest payments and the loan is secured by a more valuable asset (aka if you can no longer afford your home payments, you could lose your house to the bank).
– Mortgage brokers earn more, as they are often paid with a commission– usually 1 to 2 percent of the loan amount.
In many situations, the ONLY person who is motivated to make sure you don’t overspend is YOU.
Protect yourself and your future home by finding out how much home you can ACTUALLY afford so you can buy your dream home and still live a happy, comfortable lifestyle.

How Much House Can I Afford – Rule of Thumb

25% or less of your TAKE-HOME PAY should go towards your TOTAL MONTHLY HOUSE PAYMENT, which includes:
  1. Mortgage Payment: Principal + Interest
  2. Property Taxes
  3. Homeowner’s Insurance
  4. HOA fees – If Applicable
  5. PMI – Private Mortgage Insurance – Applicable if you paid less than 20% down

How to calculate how much home you can afford

1. Add up your total monthly income (take-home pay)

You + Spouse = Total

Example: If you make $3,000 after tax and other deductions and your spouse makes $2,000 = $5,000 total monthly take-home pay

2. Multiply it by 25% to get your maximum housing payment

Example: Your take-home pay is $5,000/month. x .25 = $1,250 (Your Maximum Monthly House Payment)

3. Use a mortgage calculator to see how much house you can afford

From here, the amount of house you can buy depends on:

  • How much money you put down (Put at least 20% down to avoid paying PMI)
  • Interest rate (ALWAYS get a fixed-rate mortgage. Avoid ARMs – Adjustable Rate Mortgage)
  • Property Taxes
  • Homeowners Insurance
  • HOA Fee (If applicable)
  • PMI (Private Mortgage Insurance – Applicable if you put more than 20%)

Home Affordability Calculator

Use this mortgage calculator to determine how much house you can afford without going over your Maximum Monthly Housing Payment.

How Much House Can I Afford Calculator

Comparison 1: 25% of Take-Home Pay

One recommendation is that your monthly housing cost be no more than 25% your monthly take-home pay.
Why 25&? This allows you have money left over to pay for other necessities and financial priorities.

Budget Percentages Guide

These are guidelines, but they add up to 100% in total, meaning if you spend more in one area, you need to be spending LESS in another.
And even if, for example, you don’t choose to spend 10% on giving, you might end up spending significantly more than 5% on health, so track and evaluate your expenses (aka budget) before you decide that you can simply choose to buy a bigger house.
Note: Savings is only 10% in this chart because these are percentages of your TAKE-HOME Pay. I’m assuming a lot of your retirement savings would be using pre-tax dollars (e.g. 401k contributions), which would not be included in your take-home pay — making your effective savings rate significantly higher than 10% — as it should be — especially if you want to ​retire early​).
Budget Categories - Dave Ramsey

Comparison 2: Zillow’s DANGEROUS Recommendation

According to Zillow’s home affordability calculator, they will allow your debt-to-income ratio to go up to 36% of your GROSS income.

Assuming 70% of your gross income ends up being take-home pay (after taxes, health care premiums, 401k contributions, etc.), that would mean lenders are willing to let you take on up to 51% of your take-home pay in housing costs.
This should SHOCK YOU! The reason why: A 51% housing payment leaves only 49% of your take-home pay for EVERYTHING else.
In addition to your housing, you’d only be able to cover:
  • Saving – 9% (not enough)
  • Food – 10%
  • Utility – 5%
  • Transportation – 10%
  • Health/Medical – 5%
  • Insurance – 10%

Total: 49%

You don’t have ANY MONEY leftover for:

  • Recreation (sports, music lessons, activities)
  • Vacations
  • Personal spending (haircuts, clothes)
  • Miscellaneous (birthday parties, Christmas presents)

You’re more than house poor though–you’re also not saving enough to be able to be both on track for retirement and replenishing your emergency fund, which means you’re vulnerable in case of:

  • Job loss
  • Health issues (both medical bills and loss of income)

Rent vs. Buy: Are you financially READY to buy?

Some people who end up in huge debt were there partly due to a home-buying nightmare.

They had:

  1. Bought a home too early–before they were financially prepared and/or
  2. Bought a more expensive home than they could afford.

Here are some financial milestones you should hit BEFORE buying a home:

 1. DEBT: Be debt-free (other than a conventional fixed-rate mortgage, if this home you’re considering is a second purchase)

This means no home equity loans, credit card debt, or consumer debt of any kind. If you’re really motivated to get into a home, attack that debt fast so you can start working on getting into a home you love!

2. EMERGENCY FUND: Have a fully funded Emergency Fund (3-6 months of expenses)

Homes, even relatively new homes, can surprise you with unexpected maintenance costs. A fully-funded emergency fund acts as insurance to protect you from going into debt for expensive home repairs.

3. DOWN PAYMENT: Have enough cash for a 10-20% down payment and a 15-year fixed-rate mortgage

Paying 20% or more down will help you avoid paying expensive PMI (Private Mortgage Insurance)–an expensive cost that you would have to pay on TOP of your down payment

Not sure if buying a home is right for you? Check out our article Rent vs Buy: Are you READY to BUY your dream home or should you RENT?
Rent Vs. Buy - How to Decide

How Much House Can You Afford? Stick to the 25% Rule-of-Thumb

In conclusion, stick to the 25% Rule to be able to both keep your home, financial peace and sanity. You will likely not regret buying a home you can afford, but you will definitely regret getting in over your head and setting yourself up for a financial nightmare.

Cannot Afford to Buy A Home Yet?

You are making the right move by not jumping the gun and setting yourself up for a financial nightmare. If you’re feeling deflated–don’t! YOU are capable of hitting these milestones and THEN getting your dream home.

If you need help and encouragement, start with my Money Fit Challenge and follow along on Instagram and Facebook.

 

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