How much house can you afford to buy?
Whether you’re renting or planning to upgrade from a current home, it’s a key starting point when you begin your search. How much money you make impacts the mortgage you can afford, but it’s far from the only factor.
In this article, I’ll explain money expert Clark Howard’s approach to deciding on an appropriate home budget. I’ll also highlight the costs you need to consider beyond your mortgage, the financial factors your bank will look at most closely when evaluating your loan application and where you can find a mortgage affordability calculator.
Table of Contents
- How Much House Can I Afford?
- What Size Mortgage Can I Afford Based on My Salary?
- What Factors Do Lenders Consider When Evaluating My Mortgage Application?
- Costs To Consider Beyond Your Mortgage
- What To Do if You Want More House Than You Can Afford
- Don’t Worry About Prices Crashing if You Buy Now
How Much House Can I Afford?
How much house can I afford?
It’s a loaded question. More times than not, if it’s your first mortgage, the answer is less than you realize. You need to factor in a number of home-related costs beyond your mortgage.
How much house you can afford usually isn’t the same as how much house you should buy, either.
At one point, money expert Clark Howard advised people to figure out how large of a mortgage they qualify for on a 30-year term and then step back 10% from that number. He has since changed his stance. Start with how much you’re paying in rent, he says now. Then calculate a mortgage payment that includes your current rent plus the monthly overhead costs you’re adding by owning a home.
“Ignore what you’re pre-approved for. Instead, base what you can really afford on what your current rent is. Remember with that mortgage, you’re going to also have taxes and insurance,” Clark says.
“If you’re used to paying $1,500 per month in rent, and you can secure a $4,200 a month mortgage payment, are you really going to be able to come up with the $2,700 difference? How much room do you actually have in your monthly budget for more for housing?”
In some cases, Clark says, people are taking on expensive, time-consuming commutes because they have to search outside of their city for an affordable house.
“Housing prices escalated so much over the last few years. You’ve got to be careful you don’t end up house-poor where you take away from everything else you should be doing in your life because you’re trying to stretch to the breaking point to afford a house,” Clark says.
What Size Mortgage Can I Afford Based on My Salary?
Your income matters a lot when a bank figures out how much mortgage you can afford. After all, most people get 30-year mortgages. But how much money you make is far from the only factor that lenders evaluate, which I’ll discuss more in the next section.
Try These Home Affordability Calculators
If the only thing you’re looking for is a rough estimate on how much money you may be able to secure through a mortgage loan as fast as possible, you’re in luck. There are several good home affordability calculators that will tell you in five minutes or less.
These calculators are almost never actionable. So don’t take the number that one calculator spits out as fact. Some calculators also allow you to adjust how much home you can afford to a figure that’s more conservative or more aggressive based on factors such as your income, credit score and ZIP code.
Option 1: Bankrate
This calculator does a nice job of getting you to think about your total financial picture. That includes income spots for investments and alimony, not just wages, real estate taxes, homeowner’s insurance and four different fields for monthly debts.
Option 2: Forbes/Better Mortgage
Put in your available assets (a down payment stand-in), income, credit score and ZIP code.
This simple calculator will spit out the most expensive home you can buy, the required down payment, closing costs, required cash reserves and monthly payment (including homeowners insurance and property tax).
Option 3: SmartAsset
Input your location, marital status, annual income, down payment, monthly debt and credit score.
SmartAsset will offer you a sliding scale from conservative to aggressive. It also breaks down your estimate to include closing costs, required cash reserves, mortgage payment and APR.
Option 4: Zillow
You can click on “advanced” and modify inputs such as debt-to-income ratio, interest rate and property tax percentage. But Zillow will give you an answer after type in just three fields: annual income, monthly debts and down payment.
I enjoy the sliding scale Zillow displays from what you can afford to buy in cash with no mortgage to an estimate of the maximum loan amount you could get approved.
What Factors Do Lenders Consider When Evaluating My Mortgage Application?
Your lender will consider many factors when determining whether to approve you for a mortgage loan, and if so, for how much.
Some of those factors are out of your control. For example, the interest rate that the Federal Reserve sets, the macroeconomic environment and the bank’s own balance sheet.
However, there are six major factors that you control that go a long way in determining how much money to lend to you (and at what interest rate):
- Income: The more provable, reliable income you have, the more home you’ll be able to afford — at least in a vacuum. High long-term income won’t help if you also owe a mountain of debt.
- Debt: Your lender will look at your monthly debt obligations, in other words, the minimum amount you owe each month for credit card, auto, student loan, personal loan or any other type of debt. Your lender also will evaluate your debt-to-income ratio (DTI). (Make $3,000 and owe $1,000 in total debt payments per month? You have a 33% DTI.) There’s also a front-end DTI (how much you currently owe relative to your income) and a back-end DTI (how much you will owe relative to your income after adding your mortgage to your debt).
- Down Payment: There’s no magic number. Different types of mortgages include different requirements. But 20% is a standard minimum. That will help you avoid paying private mortgage insurance and often gets you access to the best loan structure.
- Loan Term: A podcast listener asked Clark whether to make a down payment worth 33% of the cost of the house. Clark is a huge fan of 15-year mortgages instead of 30-year mortgages. He says that if you can afford a larger down payment, and it makes a 15-year mortgage more feasible for you, go for it. Shorter loan terms mean higher monthly payments and lower interest rates.
- Credit Score: An excellent credit score works to your advantage in two ways. It theoretically increases the amount of the loan that a lender is willing to approve and it helps secure a better interest rate on that loan. Clark recently discussed why you don’t need to stress about achieving an 800 score.
- Cash Reserves: Loans often require between zero and six monthly payments’ worth of cash reserves. Regardless of the requirement, you’ll need money to pay closing costs. Expect to pay 2 to 5% of the cost of your house at closing, Forbes says.
Costs To Consider Beyond Your Mortgage
The dollar figure attached to your mortgage can seem intimidating and like an ultimate goal at the same time. For many people, it’s the largest purchase they’ll make in their lifetime.
It’s a little dizzying to consider all the costs of owning a home beyond your mortgage. But it’s a necessary exercise to decide responsibly how much house you can afford based on your salary.
Estimating the costs outside of your mortgage can prevent disappointment if piecing together a down payment is a huge long-term goal of yours. It may be a downer to reach what you think is the finish line only to realize you’re not yet prepared to buy the house you want due to the hidden costs.
Consider the following costs before you answer the question, “How much house can I afford?”
If you’ve never had a mortgage before, or if it has been a long time since you last signed for one, make sure you research and understand how significant closing costs can be.
If you haven’t accounted for closing costs in the amount of cash that you can put toward your down payment, it could lower the amount of house you’re able to afford. By the same token, rolling your closing costs into your financing can also impact the size of the mortgage you’re able to afford.
Thinking about paying the IRS isn’t fun. But it’s imperative that you account for property taxes before determining how much house you can afford to buy on your salary.
Check with a local real estate agent. Or check the county assessor’s website to get an idea of how much you’d owe every year.
The average American paid 1.08% in property taxes as of 2020 according to H&R Block. That’s $7,200 per year on a $400,000 house.
Don’t forget to account for insurance. This can make a serious dent in your budget if you’re currently paying renter’s insurance.
Areas with more frequent claims (perhaps due to crime or storms) tend to lead to more expensive insurance prices. You may need to consider flood insurance in some places.
Clark advocates for raising your deductible and not making small claims to lower your home insurance premiums.
The larger and older your home is, the more you can expect to spend on maintenance. Maintenance expenses usually are irregular but large. For instance, the national average for a roof replacement is $8,000, Forbes says.
You may consider setting aside funds for maintenance every month. That way you’ll have some money earmarked for repairs as needed.
You’re likely paying utilities already, whether you rent or own. However, depending on the house you buy, your utility costs could increase.
Furniture and Decor
Are you considering a larger house? Or do you own a limited amount of furniture and decor? This can be a tremendous expense in the aftermath of a home purchase. After all, who wants to live in an empty house?
Clark says you can save a lot of money buying your furniture at Costco. Regardless, it would be a shame to be so aggressive about the mortgage you can afford on your salary that you can’t afford a couch for your living room or a mattress for your additional bedroom.
A homeowner’s association (HOA) is a private volunteer group that enforces rules and/or adds amenities (such as security) for a community. Investopedia says the average annual HOA fee is $200 to $300, although it can vary considerably.
Banks consider your debt-to-income ratio. But they won’t account for the money you want to set aside every month for retirement, the European vacation you take every summer or the car you’re planning to buy in 18 months.
You could also be moving into an area where daily and weekly purchases such as food and gas are also more expensive.
What To Do if You Want More House Than You Can Afford
Many of us have heard of the FIRE movement – living lean to an extreme in order to retire as soon as possible. But this is America, the land of opportunity and capitalism. There’s nothing wrong with dreaming big.
Earlier in the article, I mentioned the factors you control that can help you afford a more expensive house. That includes paying off debt, saving more money for your down payment and increasing your income.
Without getting too philosophical, consider the sacrifices you may be willing to make in terms of the size, location and age of your house. Perhaps you can learn to be happy with the house you can afford right now.
If you’re intent on working toward something bigger, Team Clark has some great resources on how to save money, how to reduce expenses, side jobs you can do from home, how to make an extra $100 a day and how to ask for a raise.
Don’t Worry About Prices Crashing if You Buy Now
Have you ever been looking forward to dessert at a restaurant, but you order so much food for your main course and appetizer that you’re stuffed before your waiter brings you the dessert menu?
You don’t want to commit the financial equivalent of that when you buy a house. Your top priority is to avoid overextending yourself to take on the largest possible mortgage that a bank will lend to you, Clark says.
However, the fact that the housing market has soared so high, so fast wouldn’t scare Clark from buying right now, he says. That’s assuming two things are true:
- You keep your monthly mortgage conservative enough that you can comfortably pay for everything else in your life.
- You’re planning to live in the house for at least a decade.
That last point is crucial to Clark.
He doesn’t expect home prices to crash as they did following the Great Recession when a supply glut existed. Mortgage rates are moving higher along with the Fed raising interest rates. That’s causing some softness in the housing market. And a recession seems inevitable.
“Then you stand a great chance you’re going to be upside down in your home. And you’re not going to want to sell into a loss,” Clark says.
That won’t matter if you won’t consider selling for at least a decade, he says.
“There’s actually an advantage to the higher mortgage rates. Higher mortgage rates aren’t with us forever. So if you’re able to buy it at a somewhat lower price than it would be otherwise, it means that when mortgage rates come down at some point in the future, you’re able to refinance your loan,” Clark says.
“You would’ve paid less for your home than if the mortgage rate stayed at 3%, which creates some artificial demand where people push forward on buying a property.”
Clark says that, unlike the Great Recession, though, there’s not a crazy oversupply of housing inventory. Especially since people who locked in mortgages at 2 or 3% are much less likely to want to sell now that the average mortgage rate is about 7% at the end of October 2022.
Figuring out how much you can and how much you should spend on a home takes real work. But it’s a worthwhile exercise.
Be thorough, because taking on a mortgage can have an outsized impact on your financial health. Luckily, there are some great tools and data available to help you understand what you can comfortably afford.
Are you looking for a great starting budget but don’t have time for deep research right now? A good mortgage affordability calculator can give you a nice ballpark number in five minutes.