After falling for nearly a decade, homeownership rates have steadily climbed since 2016 lows. A January 2023 survey by Nerdwallet suggested that owning a home was a priority for more than 80% of the adult population, with about 11% of surveyed adults intending to buy a home over the next twelve months.
A home is often the largest purchase families will make. Some families may spend decades in a home, witnessing multiple generations pass through. For many families, a primary home is an important savings and investment vehicle. Providing a source of equity in retirement as the mortgage is paid off and the value — hopefully — steadily rises.
Trying to answer the question of “How much house can I afford?” can be complicated and stressful. We'll go over the total costs involved in owning a home and guide you to determine how much house you can afford.
Erika Taught Me
- Monthly housing costs of homeownership are made up of mortgage interest and principal payments, property taxes, homeowners insurance, HOA or condo fees, elevated maintenance and utility costs, and possibly private mortgage insurance.
- Rules of thumb for how much house you can afford are typically based on your debt-to-income (DTI) ratio.
- Monthly housing payments can be affected by prevailing interest rates, the down payment, your DTI, and your credit score.
What contributes to a mortgage payment?
Monthly mortgage payments consist of two components: interest and principal. Cutting the loan balance through principal payments repays the bank, bringing you closer to outright homeownership by reducing overall debt. Interest payments constitute a fee for borrowing money.
The mortgage payment is driven by three key factors:
- Loan amount
- Duration of the loan
- Interest rate
The loan amount includes the purchase price minus any down payment, though sometimes closing costs are added back to the loan amount for borrowers with less cash upfront.
Typically paid monthly, mortgage payments span 360 months for a 30-year mortgage and 180 months for a 15-year mortgage.
Construct the payment to ensure the loan amortizes evenly (with a fixed rate), covering interest and a portion of the principal initially. As principal decreases, interest lessens, allowing the same payment to cover more principal, continuously reducing the loan balance. Ultimately, the final payment clears any remaining balance at the chosen duration's end.
A simple online mortgage calculator 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.
Variable Rate Loans
Variable-rate loans typically provide a lower introductory rate that will adjust in the future based on a prevailing market index. Be wary: these are precisely the types of loans that caused so many bankruptcies during the 2008 financial crisis as borrowers suffered payment shock when their monthly mortgage payments suddenly spiked.
The principal and interest payments are just part of the monthly housing costs to consider.
How much house can I afford: Other homeownership costs
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 helps cover the cost to repair or replace your home in the event of perils such as fire or theft. Home insurance rates vary widely by state, but the average is about $230/month for a $300,000 dwelling.
Private Mortgage Insurance (PMI)
Borrowers may be forced to purchase private mortgage insurance if providing a down payment of less than 20%. PMI could range between 0.2% to 2.0% depending on your down payment and credit score.
Condo owners pay toward the upkeep of common areas such as landscaping, patios, amenities such as swimming pools, electricity and property taxes, and on-site staff. Condo fees vary substantially by city, averaging $600 in Los Angeles and more than $1,300 in New York.
Trash and water
Water, sewage, and trash removal are often included with rent. However, homeowners have to pay for these with average costs around $45/month for water bills, $67 for sewage, and $25 to $100 for trash collection.
A meaningful benefit of renting is that 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, such as a refrigerator and dishwasher.
How much house can I afford?
A common rule of thumb for housing affordability is the 28/36 rule, which suggests 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.
For example, if you are a married couple earning a combined $150,000, your total state and federal income taxes might be 34% of your income. If your total debt payments are above the 36% DTI rule of thumb, then that leaves less than 30% of your income for everything else. And this includes savings, healthcare, food, home and auto maintenance, education, entertainment, travel, and other miscellaneous expenses.
So the 28/36 rule is there as general guidance, but it doesn’t replace a detailed budget or personalized financial plan based on your family’s needs. But we’ll use this rule for our estimates of housing affordability.
Related: How to get a mortgage
How much house can I afford: Using DTI to calculate housing affordability
Suppose George earns $100,000 per year before taxes. George’s total debt-to-income ratio per the 28/36 rule should be no more than 36% of his gross monthly income — $36,000 per year or $3,000 per month. And his housing costs should be no more than $28,000 per year or $2,333 per month.
However, George also has monthly debt payments: student loans and a car loan that combine for $1,000/ month. This leaves him with $2,000 per month to spend on housing to keep his total DTI under 36%, even though $2,000 per month is less than 28% of his gross income.
How do interest rates affect housing affordability?
The interest rate is a key factor in determining the monthly mortgage payment for a given loan amount and duration. Let’s again use George as an example, who has $2,000 per month to spend on housing to keep his DTI under 36%, and an online mortgage calculator from Fannie Mae.
If George has enough money saved for a 20% down payment, he 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/month. George would have to reduce the home price he can afford to $300,000 to make up for the higher interest rate.
How do credit scores affect housing affordability?
Typically, borrowers with credit scores above 760-780 are deemed to have excellent credit and obtain the lowest mortgage rates available. However, borrowers with lower scores may face higher interest rates on their mortgages, which reduces housing affordability as we saw with George. This is why it's often recommended 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. First, it directly reduces the loan amount, which reduces the monthly mortgage payment for a given interest rate and loan duration. For conventional loans with under 20% down payment, lenders may mandate private mortgage insurance to mitigate risk.
PMI exists to help the lender — not the borrower — by insuring the lender against losses in the event of non-payment by the borrowers. Consider why: Suppose George takes out a $200,000 loan for a $200,000 property — so zero down payment. Then a recession hits which causes George to lose his job and simultaneously for the house to decline in value. If he can no longer make his monthly payments, the bank may foreclose on George and take over the house. But if the value of the house declines by 10% to 15%, the bank may lose money. Selling for less than the loan plus additional selling costs such as fixing up the property and paying a commission to the real estate agent. However, with a 20% down payment, the bank has some cushion for the home price to fall without losing money in the event of foreclosure.
Let’s return to the online mortgage calculator from Fannie Mae. George is interested in a $325,000 home with a 30-year mortgage at a 5% interest rate. With a 20% down payment ($65,000), George’s monthly payment will be just over $2,000. This includes estimated insurance, property taxes, and HOA costs.
However, suppose George doesn’t have $65,000 and instead can only afford a 10% down payment. This not only increases the loan amount by $32,500 but also adds a $107 monthly PMI payment. Bringing the total monthly mortgage payment up to $2,287 and above George’s DTI limit.
How much house can I afford based on my income?
Let's consider a few different scenarios for housing affordability based on different incomes.
Annual income: $100K
As discussed above, George earns $100k/year. By the 28/36 rule, his total debt-to-income should be less than $36,000/year or $3,000/month. While his housing expense should be no more than $28,000/year or $2,333/month. Using this rule, he can afford the lesser of (i) $2,333/month or (ii) $3,000/month minus monthly non-housing debts.
Annual income: $70K
Jaime earns $70k/year. By the 28/36 rule, her total debt-to-income should be less than $25,200/year or $2,100/month. While her housing expenses should be no more than $19,600/year or $1,633/month. Using this rule, Jaime can afford the lesser of (i) $1,633/month or (ii) $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. While his housing expenses should be no more than $11,200/year or $933/month. Using this rule, Steve can afford the lesser of (i) $933/month or (ii) $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. Which 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 home buying until the buyers 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
George earns $100k/year in New York and files taxes as a single individual. His 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. Her 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.
Related: What Is A Mortgage Broker?