How Much House Can I Afford to Buy?

Reader Question: We are just getting started with the home buying process, setting our budget, etc. How do I know how much house I can afford to buy?

Without a doubt, this is one of the most common questions asked by first-time home buyers. I’ve been answering real estate questions online for a few years now, and I’d put this one in the top-three as far as frequency goes. I’m glad you asked, because this is an area where a lot of first-time buyers go wrong.

Many people let the mortgage lender tell them how much house they can afford to buy, but this is backward. A lender cannot tell you what you can or cannot afford — it’s not their job. They can only tell you how much they are willing to lend to you, but that’s it. If you’ve been following the news over the last year or so, you’ll know that it’s possible to be approved for a loan that you later cannot afford to pay. It happens all the time in the United States, and it’s one of the primary causes of home foreclosure.

The best way to find out how much house you can afford is to reshape the question. Instead of asking how much house, ask the following: How much money can I put toward a mortgage payment each month. And to the answer this question, of course, you’ll have to do a little math with your current income and monthly expenses.

That’s the whole point of this exercise — to determine what you have to work with each month, and what you can put toward mortgage payments. Yet you’d be surprised by the number of people who skip this all-important task.

How much do you earn, and what do you owe?

To find out how much house you can afford to buy, you must determine what you can afford to put toward monthly housing payments. It’s important to start at the monthly level and work your way up, because it’s the best and most accurate way to create a budget. Here’s how to go about it:

Start with your gross monthly income. This is your “take-home” pay, after taxes. Write this number down on a piece of paper, because it’s the total sum you have available each month. If you are married, and both you and your spouse will contribute to the mortgage payments, write down your combined income.

Next, you’ll start chipping away at this amount by subtracting monthly expenses. This includes car payments and insurance, credit card payments, any other monthly debts you have, health care costs, groceries, savings and retirement plan, etc. Don’t forget to account for quality-of-life items, such as the occasional dinner out, movies, and the like. If you’re currently renting, you can leave that monthly expense off of this list, because you obviously won’t have any rent payments after buying a house (yay!).

Subtract these total monthly debts and expenditures from your gross monthly income, and the amount you are left with is what you could put toward a mortgage payment. So, how much house will this get you? To answer this question, you’ll need to use a mortgage calculator. You can find plenty of them online — just about every bank’s website has mortgage calculators on it. CNN Money, Bankrate.com, Interest.com … all of these websites have housing calculators you can use.

To start with, just leave most of the default settings as they are. Most of these calculators will have the sale price blank (obviously), but they’ll have default numbers in some of the other fields. They are usually set to the current average interest rate, a 30-year fixed mortgage, average insurance costs, etc. You’re just trying to get a rough idea of how much house you can afford to purchase, so you can leave those other settings as they are for now. Besides, you won’t know what interest rate you can qualify for until you actually apply for a loan, later on.

Start plugging some sale prices into the calculator, and then run the numbers to see how much the monthly mortgage payment would be. Instead of pulling numbers out of thin air, go on a website like Realtor.com and look at houses in the area you want to buy. This is a great way to learn how far your dollar will go in your real estate market, and to find out what type of house you can realistically afford to buy.

Can you afford to be house poor?

How much of a house can I afford to buy … and still be able to enjoy it? That’s the real question you should be asking here. I have known many people over the years who made “ego purchases” when home buying. They chose that big, nice, custom house that was at the upper end of their budget (or beyond). I’m not naming any names, but you people know who you are.

As a result of such an unwise purchase, the homeowners become “house poor.” They can afford their monthly mortgage payments, so they won’t be foreclosed on, but that’s about all they can afford. Quality of life, travel, saving money for retirement … these things are now out of reach because they bought too much house.

This is why I emphasize the monthly budgeting process I’ve described above. If you determine how much you need to spend each month for things other than a mortgage payment — and you are honest and accurate with that process — then you’ll have a pretty good idea of how much house you can afford to take on. Best of all, you won’t have to sacrifice things that are important to you.

Lastly, and briefly, I want to mention interest rates. You can make your home loan more affordable by getting a low interest rate on the loan. In order to do this, you’ll need an excellent credit score and a favorable debt-to-income ratio. Here are some articles where you can learn more about these things:

I hope this information helps you set an appropriate home-buying budget, and I wish you well in your real estate ventures.


categories Buying a Home | Brandon | datetime April 22, 2009 7:09 am

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