For most of us, buying our first home is the most important financial step we will ever take. There are so many decisions. When should we buy? Where should we look? None of these decisions are easy, but at least one of them – How much can we afford? — can be simplified with some easy estimates.
Start with Your Household Income
Household means all income, including yourself and your spouse or co-buyer. It also means income from all sources: your wages, plus any income from investments, alimony, or rental property.
According to the Census Bureau, the median household income in the US is $69,000, so in this example, our first data point will be a total monthly available income of $5750.
A Quick Estimate Using the 28% Rule
Most financial advisors caution that your monthly housing cost should not exceed 28% of your gross monthly income. For our sample household, that would be $5750 x 0.28, or $1610 per month.
While the 28% rule gives you a quick way to see the range you can afford, you need more inputs for a really good estimate. Overestimating your ability to pay could cause you to wind up “house poor”, while underestimating could make you settle for less house than you could have enjoyed. You don’t want to do either, so let’s take a closer look.
How Much Can You Put Down?
Your down payment is one of the most important factors in determining how much house you can afford, as it directly reduces the size of the mortgage you will need, as well as the interest rate and resulting amount of your payment.
To give yourself the most financing options, the ideal down payment is 20% of the purchase price. According to Zillow, the national median home price is $270,000, so 20% of that is $54,000.
If you don’t have that much saved, don’t give up. Some mortgages, such as FHA, USDA or VA, require little or no money down, although they may cost more in the long run, requiring higher interest or an extra payment for private mortgage insurance. LendingShops is happy to discuss all of the available options with you, and find the right down payment that will meet your needs.
For more details about the features of different mortgages, see our blog on “How to Find the Right Mortgage for Your Dream Home”. For now, just note that the more you put down, the more you can afford. For our sample estimate, we’ll use a down payment of 10%, or $27,000.
How Much Do You Already Owe?
You and your co-buyer will need a complete picture of your monthly debts. This should not include all expenses such as food…just your debts, including car payment, credit cards, alimony and any other fixed payments. Let’s say your total for these monthly payments is $500.
Estimate Your Real Estate Tax and Homeowners Insurance
Next, you will need to estimate the taxes and insurance on the homes in your price range. You can usually find the details in online property listings, such as Zillow and Realtor.com.
For our example, we’ll say that the taxes on your target property are $2,500 per year, and the annual homeowner’s insurance premium is $2,000. These amounts are collected once a year, but a portion is paid into an escrow account each month, so they are part of your monthly mortgage payment. In this case, the combined monthly cost of taxes and insurance will be $375.
Estimate Your Interest Rate
The last item you will need to estimate is your interest rate. You can look online using resources such as Bankrate.com, or check with your credit union or bank. Rates will vary, depending on the type of loan (conventional, FHA or VA) and on the amount you can put down. Bear in mind also that the lowest rates quoted are based on having a solid income and a top credit score. For our example, we’ll use 4%.
Now Use Your Estimates to Calculate Affordability
Many popular real estate and banking websites offer online tools to calculate mortgage affordability. Using the basic numbers in our sample ($69,000 income and $500 in monthly debts) the Zillow calculator estimates that we can afford a house up to $275,184. Other popular affordability calculators by Quickenloans, Investopedia and Nerdwallet can give you more detailed views of your estimated data.
Bankrate.com allows you to enter income from wages, investments and other income, plus expense details and estimated mortgage terms. Using the sample data we developed in this article, Bankrate estimated an affordable home amount of $277,306.
Once you have determined your budget, you can use the LendingShops mortgage calculator to calculate your mortgage payment. https://lendingshops.com/mortgage-calculator/ With our calculator, you can input the loan amount, the interest rate, and the term.
Now that you know how to determine what you can afford — it’s time to plug in your own estimates and find your Dream Home! When you do, let a LendingShops advisor help you find the right lender. You can set up an appointment online at www.LendingShops.com or call us today at (972)-458-8888.
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