One of the simplest ways to assess whether a house is affordable is by evaluating your household income and comparing it with the expected expenses for the type of home you want to purchase. This includes mortgage payments. A common guideline suggests that you should not spend more than 28% of your monthly income on housing expenses.
However, several factors can complicate this calculation. To get an accurate estimate, consider your outstanding debts, credit score, initial down payment, assets, and other recurring costs associated with homeownership, such as home insurance.
Let’s walk you through the eight key steps to determine your budget for buying a house.
Step 1: Calculate Your Income and Financial Obligations Using the 28/36 Rule
A popular rule of thumb for determining your housing budget is the 28/36 rule. This guideline advises that you should allocate no more than 28% of your pre-tax income toward housing expenses and a maximum of 36% toward total debts.
This rule helps determine your debt-to-income ratio (DTI), which lenders use to evaluate your financial situation when assessing mortgage applications. The DTI ratio considers all debts, including student loans, car payments, mortgage payments, and property taxes.
For mortgage approval, lenders generally prefer a DTI ratio below 36%. However, research by ICE Mortgage Technology shows that the average DTI ratio for homebuyers in the U.S. hovers around 38%.
“Lenders may approve DTI ratios up to 45%,” says Melissa Cohn from William Raveis Mortgage. “Banks typically expect you to allocate between 43% and 50% of your income toward your new home and other monthly expenses.”
Example Calculation for a $72,000 Salary
If you earn $72,000 per year (above the $65,000 U.S. average, according to the Bureau of Labor Statistics), this equates to $6,000 per month.
- The 28% rule suggests you should spend $1,680 per month on housing.
- Your total debt payments should not exceed $2,160 per month.
- If your lender allows a 45% DTI ratio, your total monthly debt, including housing, should not exceed $2,700.
Step 2: Assess Your Down Payment and Savings
Lenders prefer borrowers who can contribute toward the home purchase. While a 20% down payment is ideal for securing the best mortgage rates, it’s not always required. According to the National Association of Realtors (NAR), the average down payment in the U.S. is 15%.
You may qualify for a mortgage with a lower down payment, but lenders also assess your financial reserves. Melissa Cohn states that lenders often require reserves covering 2–4 months of mortgage payments, which may be held in savings or retirement accounts.
Step 3: Understand How Your Financial Situation Affects Interest Rates
Your mortgage interest rate depends on several factors, including your credit score, loan type, and economic conditions. Even minor rate fluctuations can impact your total loan cost by thousands of dollars.
Key factors affecting interest rates include:
- Debt-to-Income Ratio: A higher DTI usually leads to higher interest rates.
- Loan Term: A 15-year loan generally has lower interest rates than a 30-year loan, though monthly payments are higher.
- Loan Type: FHA, VA, and USDA loans may offer different rates than conventional loans.
Step 4: Choose the Right Home Loan
Most homebuyers use mortgages to finance their purchases. Depending on your financial situation, different mortgage options may be more suitable.
Common Loan Types:
- Conventional Loans: Offered by private lenders, often requiring a credit score of 620+. Down payments range from 3% to 20%.
- FHA Loans: Backed by the Federal Housing Administration, these are ideal for borrowers with lower credit scores (as low as 500 with a 10% down payment, or 580 with a 3.5% down payment).
- VA Loans: Available to eligible veterans and military members, requiring no down payment and no set credit score.
- USDA Loans: Designed for rural homebuyers, offering zero down payment, though lenders prefer a 620+ credit score.
Step 5: Get Preapproved for a Mortgage
Getting preapproved helps you determine your home-buying budget and strengthens your position as a buyer. Preapproval letters, which are typically valid for 30 to 90 days, show how much a lender is willing to finance.
- You can shop around for rates within 45 days without further credit score penalties.
Step 6: Factor in Recurring Homeownership Costs
Beyond mortgage payments, homeowners should budget for ongoing expenses such as:
- Home Insurance: Required for most mortgages, with costs varying by location and property age.
- Property Taxes: Typically 0.5% to 2.5% of the home’s value.
- HOA Fees: Applicable for condos and planned communities.
- Utilities: U.S. households spend an average of $583/month (Move.org).
- Maintenance Costs: Allocate 1% of your home’s value annually.
Step 7: Prepare for Closing Costs and Emergency Funds
Closing costs typically range from 3% to 6% of the home’s purchase price, covering appraisals, attorney fees, and title insurance.
Additionally, having an emergency fund is crucial. Experts recommend saving 3–6 months’ worth of living expenses to cover unexpected repairs or financial setbacks.
Step 8: Use a Mortgage Calculator
To ensure affordability, utilize the mortgage calculator available on each Homes.com listing. This tool allows you to:
- Adjust your payment amount, interest rate, and loan term.
- Estimate property taxes, HOA fees, and home insurance costs.
Final Thoughts
It’s essential to evaluate your income, debts, assets, and credit score to determine how much house you can afford.
Don’t just consider the loan amount and interest rate—factor in home insurance, utility bills, and emergency savings to avoid financial strain. While purchasing a home involves significant costs, the potential return on investment is substantial. In 2023, home sellers earned an average profit of $121,000, according to ATTOM Data, proving that real estate remains a lucrative investment
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