How Much House Can I Afford?

 A home is often the largest purchase you will make. And some of us may spend decades in a single home, with multiple generations of our family passing through. A home is also an important savings and investment option — it can be a source of equity in your retirement once the mortgage is paid off and the value of it (hopefully) steadily rises. 

But figuring out what home you can afford can be complicated and stressful, despite being something that many of us want. A survey in January 2023 by Nerdwallet said that owning a home was a priority for over 80% of the adult population. And 11% said they intended to buy a home within the next 12 months.

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What Makes Up a Mortgage Payment? 

Monthly mortgage payments consist of two components: interest and principal.

The principal is the overall amount that you borrow. Your principal payments are what you repay to the bank and bring you closer to outright homeownership. Interest payments are the fee you have to pay for borrowing money.

Your mortgage payment is driven by three key factors:

• Loan amount: This is the purchase price minus any down payment, though sometimes closing costs are added back to the loan amount for borrowers with less cash upfront.
• Duration of the loan: The most common mortgage terms are 30 years and 15 years. The longer the loan, the more you'll pay in interest overall. But a shorter loan means higher monthly payments.
• Interest rate: Rates can be fixed or variable. If it's fixed, you'll pay the same rate for your entire loan, which is good for you if rates go up, but not if they drop and you're stuck paying a higher rate. If it's variable, it can change — which is good for you if rates go down, but not if they go up.

To see how it all comes together, this online mortgage calculator from Fannie Mae shows that a $300,000 home with a 20% down payment on a 30-year loan at a 6% interest rate has a monthly payment of just over $2,000. 

Other Homeownership Costs

Principal and interest payments are just part of the monthly housing costs to consider. 

Once you get a mortgage, there are several costs associated with homeownership besides the mortgage payments. These could include:

• Homeowners Association (HOA) dues: The homeowners association typically manages the development and is responsible for community spaces, such as swimming pools and landscaping. 

• Homeowners insurance: Homeowners insurance helps cover the cost to repair or replace your home in the event of disasters like fire or theft. Home insurance rates vary widely by state, but the average is about $230 per month for a $300,000 dwelling. 

• Private mortgage insurance (PMI): If you put down less than 20% for your down payment, you may have to pay PMI. This protects the lender in case you stop paying. PMI can range from 0.2% to 2.0%, depending on your down payment and credit score. 

• Condo fees: Condo owners pay for the upkeep of common areas such as patios and swimming pools, as well for as on-site staff. Condo fees vary by city, averaging $600 in Los Angeles and more than $1,300 in New York.

• Repairs: When you rent, the landlord is responsible for most repairs. As an owner, you’re responsible for hiring general contractors, electricians, and plumbers, and replacing or fixing appliances. 

• Trash and water: Water, sewage, and trash removal are often included with your rent. When you own, average costs are around $45 per month for water, $67 for sewage, and $25 to $100 for trash collection.

How Much Mortgage Can I Reasonably Afford? 

A common rule of thumb for housing affordability is the 28/36 rule. It says that your housing costs should be no more than 28% of your gross monthly income (pre-tax). Your total debt-to-income ratio (DTI) should be no more than 36% of your gross monthly income. 

Your DTI is how much debt you have compared to how much you earn. If your total debt payments are above the 36% DTI, then that leaves less of your income for things like savings, healthcare, food, home and auto maintenance, education, entertainment, travel, and other miscellaneous expenses. 

While the 28/36 rule is good general guidance, it doesn’t replace having a detailed budget or personalized financial plan based on your own needs. But we’ll use this rule for our estimates of housing affordability. 

Using DTI to calculate housing affordability  

Let's say you earn $100,000 per year before taxes. According to the 28/36 rule:

• Your total DTI should be no more than 36% of your gross monthly income — so, $36,000 per year, or $3,000 per month
• Your housing costs should be no more than $28,000 per year, or $2,333 per month

However, let's say you also have monthly debt payments: student loans and a car loan that combine for $1,000 per month. This leaves you with $2,000 per month to spend on housing to keep your total DTI under 36% — even though $2,000 per month is less than 28% of your gross income.

READ MORE: How to Get a Mortgage

How Do Interest Rates Affect Housing Affordability? 

The interest rate is a key factor in determining your monthly mortgage payment. It's a good idea to use an online mortgage calculator to see how big of a difference it can make.

For example, let’s say you have $2,000 per month to spend on housing to keep your DTI under 36%.

If you have enough money saved for a 20% down payment, then you can afford a home valued at $325,000 at a 5% interest rate for 30 years.

However, if the interest rate increases to 6%, that mortgage payment jumps to $2,167 per month. 

You would have to reduce the home price you can afford to $300,000 to make up for the higher interest rate. 

How Do Credit Scores Affect Housing Affordability? 

Typically, you need an excellent credit score above 760-780 to get the lowest mortgage rates. This means that borrowers with lower scores may face higher interest rates, which reduces housing affordability. It's not fair, but it's a reality.  

That's why it's smart to work on increasing your credit score before applying for a mortgage.

How Does a Down Payment Affect Housing Affordability? 

The down payment affects housing affordability in two ways.

Firstly, for conventional loans with under 20% down payment, lenders may mandate private mortgage insurance (PMI) to mitigate their risk if you don't pay. 

Here's why: Say you take out a $200,000 loan for a $200,000 property — so zero down payment. Then a recession hits which causes you to lose your job and simultaneously for the house to decline in value. If you can no longer make your monthly payments, the bank may foreclose and take over the house.

But if the value of the house declines by 10% to 15%, the bank may lose money. With a 20% down payment, the bank has some cushion for the home price to fall without losing money in the event of foreclosure. 

Secondly, a higher down payment reduces the overall loan amount, which reduces the monthly mortgage payment.

Say you're interested in a $325,000 home with a 30-year mortgage at a 5% interest rate. Based on the Fannie Mae calculator, with a 20% down payment ($65,000), your monthly payment will be just over $2,000. (This includes estimated insurance, property taxes, and HOA costs.) 

However, suppose you don't have $65,000 and instead can only afford a 10% down payment. This not only increases your loan amount by $32,500 but also adds a $107 monthly PMI payment.

This brings the total monthly mortgage payment up to $2,287 and above your DTI limit. 

READ MORE: How Long Is a Preapproval for a Mortgage Good For?

How Much House Can I Afford Based on My Income?

Let's look at a few scenarios for housing affordability based on different incomes.

Annual income: $100K

Aisha earns $100k/year. By the 28/36 rule:

• Her total DTI should be less than $36,000/year or $3,000/month
• Her housing expenses should be no more than $28,000/year or $2,333/month 

Using this rule, she can afford the lesser of $2,333/month or $3,000/month minus monthly non-housing debts.

Annual income: $70K

Jaime earns $70k/year. By the 28/36 rule:

• Their total DTI should be less than $25,200/year or $2,100/month
• Their housing expenses should be no more than $19,600/year or $1,633/month

Using this rule, Jaime can afford the lesser of $1,633/month or $2,100/month minus monthly non-housing debts.  

Annual income: $40K

Steve earns $40k/year. By the 28/36 rule:

• His total debt-to-income should be less than $14,400/year or $1,200/month
• His housing expenses should be no more than $11,200/year or $933/month

Using this rule, Steve can afford the lesser of $933/month or $1,200/month minus monthly non-housing debts.  

How Much House Can I Afford According to Dave Ramsey? 

The Ramsey method suggests allocating no more than 25% of after-tax take-home pay toward housing costs. This could be a significantly lower amount than the 28/36 rule because those amounts are based on pre-tax income.

This method doesn’t consider non-housing debts because it discourages homebuying until you are completely debt-free.

Let’s revisit the scenarios using the Ramsey method and estimated taxes using an online income tax calculator. 

Annual income: $100K

Aisha earns $100k/year in New York and files taxes as a single individual. Her expected after-tax pay is $68,800.

The Ramsey rule allocates 25% toward housing, which comes to $17,200/year or $1,433/month. 

Annual income: $70K

Jaime earns $70k/year (household income) in Colorado and files taxes as a married couple. Their expected after-tax pay is $57,800.

The Ramsey rule allocates 25% toward housing, which comes to $14,450/year or $1,204/month.  

Annual income: $40K

Steve earns $40k/year (household income) in Arizona and files taxes as a married couple. His expected after-tax pay is $35,170.

The Ramsey rule allocates 25% toward housing, which comes to $8,792/year or $733/month.   

Listen to the Erika Taught Me podcast episode featuring Dave Ramsey.

Final Thoughts

As you can see, how much house you can afford depends on your personal circumstances. The formulas above can set some guidelines for estimating how much of a mortgage you can take out without putting yourself into unmanageable debt — although, with current housing prices, some of these numbers may also seem unreasonable.

That's why it's important to start investing and saving the smart way sooner rather than later. Home prices are going to keep going up, and if owning a home is your dream, you need to plan for that.