A house will likely be the biggest purchase of your life, so it’s important to have a clear and realistic idea of how much you can comfortably afford.
Start with an affordability calculator
The quickest and easiest place to start is with a home affordability calculator. But first you’ll need to gather the following information to get a clear picture of where you stand financially.
1. Income
To determine your monthly income, be sure to consider all revenue streams (for both you and your partner, if you’re buying a house together), including earnings from your job, investment profits, alimony, rental earnings, and any other money coming in.
2. Debt
Determining your monthly debt means adding up everything from credit card balances, student loans, car loans, child support, and any other financial obligations you might have. Be as precise as possible because your monthly debt has a big impact on how much you can reasonably afford to spend on a house. Read more here about how to determine your debt-to-income ratio, or DTI.
3. Down payment
Next, enter the amount you’ve saved for a down payment. The larger your down payment, the better terms you can likely get on your loan. Read more here about strategies for saving up for a down payment.
4. Mortgage interest rate
A higher mortgage interest rate will mean a higher payment each month.The Federal Reserve raises interest rates when it’s trying to reduce inflation, and that will have a direct impact on how much the bank charges you to borrow money. Shop around for lenders who can offer you the best rates.
For example, with a 7 percent interest rate, the payment on a 30-year, $425,000 mortgage would be $2,608 per month. At 4 percent, that figure goes down to $1,969. Even when rates are high, you can get the best rate possible if you have a high credit score, low debt, and a larger down payment.
5. Loan term
Your loan term is how long you’ll have to pay off the balance on the amount you’ve borrowed. The most popular is 30 years although some choose a shorter term. The longer the term, the lower your monthly payment will likely be.
Follow the 28/36 rule
To prevent committing yourself to a larger mortgage than you can actually afford, most financial advisers recommend following the 28/36 rule.
The rule states that you should spend no more than 28 percent of your gross monthly income on housing expenses, and no more than 36 percent on total debt. Following that breakdown, you should have enough money to pay for things like groceries, commute, entertainment, dining out, and retirement savings, and still have no problem paying your mortgage.
For example, if you earn $4,000 each month, your mortgage payment should no more than $1,120 (28 percent of $4,000), and your other debts should add up to no more than $1,440 each month (36 percent of $4,000).
For more help on determining how much you can afford, check out our articles on how to compare loan types, debt-to-income ratio (DTI), how to decrease your debt, and strategies for funding a down payment.
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