How To Calculate What You Can Afford On A Home

Whether you've already started saving for a down payment on a house, or you're just starting to toy with the idea of what it would be like to rent instead of buy, there's one question you have to answer before you can get serious about the idea of homeownership: How much can you afford to spend on a house?

Everyone from your mortgage lender to your real estate agent to, naturally, the seller of your dream home is going to have some level of interest in the answer to this question. Even if math isn't your strong point, it pays to do some work upfront to determine how much money you can afford to spend on a home; then you can shop accordingly. Here's how to determine your ideal home price.

Figure out your monthly household take-home income

For individuals who are buying a house solo, especially with steady income, this part is easy -- it gets more complicated if your spouse or partner is also going to contribute to the mortgage payment, and if anyone involved is self-employed or has sporadic income, then it can get even trickier. If you receive a steady paycheck every two weeks, twice a month, or once a month, then start with that: How much take-home pay (after taxes and other deductions like health insurance) do you see every month?

People who work in industries like food service might need to track income over time to get a sense of what their monthly take-home income is; you can't always easily predict your tips or even how many hours you'll work, but if you keep track over a period of time, you can usually see fairly clearly how everything evens out. Pay attention to the seasonality of jobs like this, too -- it's not uncommon for some jobs to experience very busy times of year interspersed with slow business, and if you're only keeping track of income during the busy time of year, you'll wind up overestimating your take-home pay for the year.

Freelancers whose business is more sporadic might also need to track income over time in order to get an accurate sense of how much they are bringing in. Start with any regular clients who contract month-to-month, then add in special projects or one-off requests to figure out what an average month of income looks like for you. In most cases, it's better to underestimate than overestimate -- you'd rather wind up with a mortgage payment you can handle easily than one you'll have to stretch to accommodate.

Determine your monthly mortgage payment

Most experts recommend that you spend no more than 25% to 33% of your monthly take-home income on housing. What this actually means in practice can fluctuate wildly, because you're not just paying back the mortgage loan on the house; you're also paying for interest on the loan, plus homeowners insurance and property taxes, which get funnelled into an escrow fund and then paid out to the insurance company and the government as needed. But for now, get started by figuring out what 25% to 33% of your monthly take-home income actually is, and use that as a jumping-off point.

For example, if between you and your spouse, you take home $6,000 every month (after taxes and health insurance and any other deductions or expenditures), then 25% is $1,500 and 33% is $2,000.

Factor in any debts

Some of us have more debt than others, but just about everyone carries debt of some kind. How much do you owe on your student loans, if anything? What about credit card debt or car loans? If you pay child support or alimony, you should factor that in, too -- and it's really best to consider your debts as part of the deductions or expenditures that happen before you see any money from your paychecks or invoices. It's not like you get a "get out of paying your bills free" card when you buy a house, and if you'll continue paying these debts for the foreseeable future, then they aren't necessarily part of your take-home income ... you aren't taking that income home; it's promised to somebody else.

It's not always possible to pay down some or all of your debt before you buy, but if you can get rid of some items -- especially high-interest debt, like credit cards -- before you start considering homeownership, try to get it done. It will raise your credit score and potentially get you a better deal on your mortgage loan in addition to providing you with some additional take-home income, not to mention the peace of mind of knowing that you're no longer indebted to at least one creditor.

Consider other expenses

These have already been mentioned, but it's worth digging into a little bit deeper so that you really understand where your money is going. A monthly mortgage payment doesn't only include the loan you're paying back and the mortgage loan interest; there are other fees wrapped into your monthly mortgage payment that you will be responsible for paying. 

One big one is homeowners' insurance, which is required by most lenders (for what are probably obvious reasons -- if something horrible were to happen to your house, such as a wildfire, the lender needs to know that there's a way to recoup the investment they made when they loaned you the money to buy the house, and with insurance, there's a better chance you can rebuild and keep living in the property). Homeowners' insurance covers many major potential disasters, but not all of them. Flood insurance is considered an extra in many areas, as is earthquake insurance, so if those are common or even somewhat likely, you might want to consider getting some extra coverage for your abode.

If you already have an insurance agent for your auto insurance or renters' insurance, it might be worth sitting down to talk to them, or picking up the phone to call them, and asking them about recommendations for insurance in the area where you want to buy. Sometimes you don't have a lot of options when it comes to homeowners' insurance; your agent can give you a ballpark idea of what you'd be spending, and your agent can also let you know if there are other policies available that can increase your coverage.

You'll also have to pay property taxes on the home you buy. It's pretty easy to look up property tax information online if you want to start estimating what you'll pay, and many online calculators factor in property taxes. This is another line item that's usually paid monthly into an escrow account and then distributed to the government when tax time rolls around.

Two more potential expenses to think about include mortgage insurance (if your down payment is less than 20%; more on that below) and homeowners association fees, if any. You don't necessarily need to know what these are upfront, but it's useful to remember they exist when you're trying to use an online calculator to figure out what you can afford.

Do you have a down payment?

If you've ever bought a car, then you might already be familiar with the concept of a down payment; it's money that you bring to the table when securing a loan to help offset the total amount of the loan you're about to take out. Many traditional loans require you to put at least 20% of the home's total value down upfront; for a house that costs $200,000, that means you should have $40,000 saved up as a down payment.

You don't have to have a full 20% of the home's sales price saved, that said -- many mortgage lenders will still provide a loan if you have 10% or even less (some loans allow you to put down just 3% of the total home value). However, if you don't have a full 20%, you'll have to pay mortgage insurance on the loan for the duration of the loan, which usually ranges between 0.5% and 1% of the total price of the loan. You can always refinance your loan after you've been paying it for more than six months, or if you have more than 20% equity built up in your house, but there's no guarantee that mortgage rates are going to remain stable or go down, so if you can, it's best to come up with the biggest down payment you can -- or talk to an accountant about your options once you've had your loan (and your house) for a while.

If you already own a house and plan to sell it before buying a new home, then chances are you'll have a full 20% down payment to put down on that new loan, but again, there's no guarantee. It depends on when you bought your house and what you paid for it, what home prices have done since you bought it, how much equity you have built up, and how much you still owe. A mortgage lender or real estate agent can help you figure out how much you can expect to net after you sell your house.

Use online calculators to figure out home price

Now that you know what you can put down on a home and how much your ideal monthly mortgage payment would be, you can use an online calculator to determine your price range. Calculators usually include the most recent mortgage interest rates being offered by the biggest lenders, which make them a useful tool, but make sure you pay attention to different adjustable fields so that you can make sure you're getting an accurate calculation. For example, most calculators assume upfront that you're going to be putting 20% down on your loan; if you don't have a full 20% and the calculator isn't adjustable, keep Googling until you find one that is.

Remember the other fees discussed above, too -- taxes, mortgage insurance, homeowners' insurance, homeowners association fees, and additional property insurance. If you can't find a calculator online that will allow you to factor all of these expenses into your monthly mortgage payment, it might be time to talk to a mortgage broker; they can help you figure out what price range would generate a monthly mortgage payment in your 25% to 33% take-home income range.

Closing costs enter the picture

It would be nice if the mortgage payment and down payment were the only things you needed to consider when buying a house -- but unfortunately, there are other costs involved that you should be prepared to cover in order to get the transaction to close. The house will need to be appraised and inspected, and the buyer is often the party that pays for both the appraisal and inspection; the title company that handles the closing will also need to be paid. Fees for the title search and title insurance (if you decide to get it) are also on the table.

One thing that some buyers forget is this: Closing costs are negotiable. If you're in a buyer's market and the seller is motivated to move on, you may be able to ask the seller to pay for closing costs, or to negotiate a split of some kind where the buyer handles the appraisal and inspection and the seller pays for any other closing costs associated with the transaction. Maybe you're not ready to talk to an agent yet -- and that's fine! -- but when you do open conversations with a real estate agent, ask them what (if any) closing costs typically get negotiated in your market and have them recommend a plan of action for you that might be able to save some money.

Don't forget utilities and maintenance

Houses don't exist in a vacuum, remaining as pristine and in as good condition forever as they are today. Similarly, your house isn't going to come with all the utilities paid for indefinitely. As a new homeowner, you're going to be responsible for the heating, water, electricity, internet, and other utilities and expenditures that make the house livable. If the roof starts leaking or your furnace goes out while you're living there, there's no landlord to call to fix it -- you are it!

A real estate agent might be a good resource for learning about average or typical utility costs in specific neighborhoods (remember that your mileage may vary, depending on how big the house you buy is), and you can talk to agents or plumbers or general contractors about which problems typically emerge in certain types of houses, and how much they cost to repair. If you can maintain a little bit of a nest egg to deal with minor and major repairs, they'll be much less stressful if you have to actually deal with one ... and if you don't, well, there's no harm in being prepared!

Other questions to ask yourself

There are a few other variables that can influence your ability to afford a house and how much house you can afford. Before you get started shopping, ask yourself a few more questions about where you are and where you need to be:

How much are you currently spending on rent, and how easy is it for you to make that rent payment every month? If you're stretching and stressing out about making rent, then you probably want to shoot for a mortgage payment that's a little less than what you're spending in rent, if at all possible.
How solid is your credit? Your mortgage interest rate and some terms of your mortgage loan are going to be directly tied to your credit score -- in fact, some lenders won't even consider giving you a mortgage loan unless your credit is above a certain threshold. Would it make sense to pay down current debt to raise that score? What else can you do to improve your credit before you buy?
What kind of access do you have to down payment funds? Are there relatives who might be willing to help you out with a down payment, or are there any programs in your area that offer down payment loans or grants, especially to first-time buyers? (Your mortgage broker can be a good resource for learning about these.)

Talk to a mortgage broker

If you haven't already, it never hurts to start a conversation with a mortgage broker about what you can afford. Of course a broker wants to help you secure a loan, but mortgage brokers can also help you figure out what (if anything) you can do to put yourself in a better position to buy in a few months or even a year. Many mortgage brokers have access to credit counseling resources and can inform you about down payment loans or grants that just require a few hours of your time in exchange for money, so it's worth looping them in early in terms of your plans to buy and using them as the resource they can be.

Don't have a mortgage broker? Find a real estate agent you trust and ask for a recommendation -- agents work with all kinds of mortgage brokers and know which ones can be trusted to get things done quickly and effectively, and which ones sometimes take a little bit more nudging. Even if you don't feel like you're ready to buy immediately, it never hurts to talk to experts and implement some of their advice.