How much house can I afford?

Buying a home is a significant financial milestone. One of the first questions you’re likely to ask during the homebuying process is: How much house can I afford?

Home affordability depends on multiple factors. Learning about them and applying them to your situation can help you figure out what might be in your budget as you look for a home.

Key takeaways

• Understanding what lenders are looking for during the mortgage approval process can give you a better idea of how much house you can afford.
• Home affordability mostly depends on income, credit score, debt and mortgage reserves.
• Once you learn about the different variables that impact mortgage approval, you can prepare your finances for a strong start when shopping for a new home.

If you’re applying for a mortgage to buy your new home, here are some variables lenders might look into when considering your mortgage application:

• Credit scores: Lenders refer to your credit scores to determine the level of risk when lending money. A stronger credit score can result in more favorable interest rates and loan terms. 
• Income: Your monthly income is one of the main components for determining what you can afford. Lenders will consider your monthly gross income—or take-home pay—when considering your mortgage application. Most financial experts agree that a potential borrower’s housing expenses shouldn’t exceed 28% of their monthly gross income. 
• Debt: Long-term debts and loan obligations—like car loans, student loans and credit cards—will be weighed against your monthly income. That comparison is called a debt-to-income ratio. It’s basically a snapshot of your monthly finances.
• Mortgage reserves: When securing a mortgage, lenders will take your down payment into consideration. They may also look at your mortgage reserves, which are assets and cash left over after your down payment and closing costs. Having mortgage reserves set aside can show that you have extra funds to cover your monthly mortgage payment if an unexpected event were to occur.

Checking your credit reports and credit scores can be an important first step when shopping for a mortgage and determining the amount of house you can afford. By reviewing your credit history, lenders determine your creditworthiness to pay back the home loan. 

A stronger credit score can help you get approved and result in more favorable loan terms. Keep in mind that you may have different credit scores that various lenders use.

There are multiple ways to monitor your credit. You can request a free report from each of the major credit bureaus by visiting AnnualCreditReport.com. CreditWise from Capital One is another option. It’s also free, whether you’re a Capital One cardholder or not, and using it won’t hurt your credit score.

Once you have your credit reports, it’s a good idea to review them and dispute any errors. If you’re not in a rush to secure a mortgage, you can also take some time to work on improving your credit scores to try to secure the best terms possible.

When you go through the approval process, lenders will consider your income and debt. However, it might also be worth considering your other expenses to ensure you’re not overextending yourself. 

Creating a budget can help you figure out how much house you can afford per month—including personal expenses that lenders may not be accounting for directly, like utility bills. Once you have a budget established, the 28/36 rule might help you determine a comfortable mortgage payment.

What is the 28/36 rule?

The 28/36 rule suggests spending less than 28% of your monthly gross income on housing costs, including the principal, interest, taxes and insurance. Those housing costs plus any other debt should then be less than 36% of your monthly gross income, according to the 28/36 rule.

The type of loan you’re securing can also play a role in the affordability of a home. In general, there are three main types of mortgage loans: conventional, Federal Housing Administration (FHA) and special programs. Each has different terms and qualifications. That means your monthly payment can vary depending on the type of loan you secure. 

Conventional loans

A conventional loan is a type of mortgage that’s not backed by a specific government program. Instead, it’s backed by private lenders, such as banks or credit unions.

There are two types of conventional loans—conforming and nonconforming: 

• Conforming loans have a maximum loan amount and abide by guidelines set by Fannie Mae or Freddie Mac, which are government-backed mortgage companies. 
• Nonconforming loans are less regulated and don’t meet the requirements set by Fannie Mae or Freddie Mac.

With a conventional loan, you can put down as little as 3%. Keep in mind, private mortgage insurance (PMI) is typically required on a conventional loan if the down payment is less than 20%. However, the premium can go away if certain terms have been met.

A conventional loan can cost less over time than an FHA loan, which can result in a lower monthly payment. But qualifying for a conventional loan can be more difficult. 

FHA loan

An FHA loan is a mortgage that’s insured and protected by the FHA, which is part of the U.S. Department of Housing and Urban Development. This type of loan can be attractive for buyers who may want to put down less than what’s required for most conventional loans. 

And the approval qualifications are less stringent than they are for conventional loans, making homeownership more accessible for those with lower credit scores. 

An FHA loan requires more insurance over the course of the loan—an up-front mortgage insurance premium and an annual premium. Keep in mind, these premiums can be rolled into the monthly payment. However, this will increase the total paid over time and can result in a higher monthly payment.

Special programs loans

Special programs loans include VA loans, USDA loans, and state and local loans. 

VA loans are backed by the U.S. Department of Veterans Affairs and funded by private lenders. They help veterans, service members and surviving spouses finance the purchase of a home. And they typically don’t require a down payment, which can make affording a home more accessible.

USDA loans are through the U.S. Department of Agriculture for low- and moderate-income homeowners in rural areas. They don’t require a down payment and could be more affordable than FHA loans. However, mortgage insurance and an up-front fee are required.

Nonprofits and state and local governments also have programs for mostly low- and moderate-income homeowners. They may be specifically for former or first-time homeowners, teachers, firefighters and other public service workers. These programs might provide subsidized loans or down payment assistance for an FHA or a conventional loan. For many of these loans, mortgage insurance is required.

The amount of money you can spend on a home is largely determined by your interest rate. That’s because the interest rate is factored into the monthly payment. Even a point or two can make a difference over the course of 15 years, 30 years or beyond.

According to the Consumer Financial Protection Bureau, you can get a general idea of the range of interest rates you might expect based on a variety of factors, such as credit score, home location, home price, loan amount and total down payment.

The amount of money you put down on a home can result in a lower monthly payment. A higher down payment can also help you avoid paying PMI because it lowers the loan-to-value ratio—the loan amount compared to the value of the asset. This can make the home more affordable since you won’t be paying an insurance premium each month.

While you may not have the exact address of your potential home in mind yet, understanding the tax rate in the areas you’re searching can help you determine your total mortgage payment. That’s because property taxes are typically paid within the mortgage payment. 

Depending on your region, property taxes can be a significant factor in calculating the home’s overall availability. Check with local agents, local tax assessors or real estate listings that include the property taxes to get a general idea of what to expect. 

Homeowners insurance is another expense that’s often added into the mortgage payment. The type of home you choose can impact your monthly insurance premium. For example, if you have your eye on an older home that requires repairs, the residence could cost more to insure than a new build.

Once you have an understanding of the purchase price, down payment, interest rate, loan term and property taxes, you can get an idea of the monthly mortgage payment. 

You can try to make the calculations yourself, but there are mortgage calculators that might make it easier. Many calculators will also provide you with an amortization schedule. That can give you an idea how much your monthly payments will go toward paying principal versus interest.

Once you have a good understanding of your monthly budget and how the mortgage payment fits in, you can better understand how much home you can afford.

Purchasing a home is likely one of the biggest financial transactions you’ll ever make. Making sure you have a strong financial foundation can set you up for success as you enter into homeownership. 

Here are a few ways to prepare your finances for this purchase: 

• Improve your credit scores. You can improve your credit scores over time by practicing good credit habits like making on-time payments. 
• Only use credit you need. Keeping your credit utilization ratio—which measures how much available credit you’re using—low can also result in a better credit score. Having a stronger credit report could secure a better rate, ultimately giving you a lower payment.
• Create a budget. Assessing your income and expenses might give you a good idea of how much you can comfortably spend per month on a mortgage. Plus, getting a better understanding of your financial habits can help you decide where you can cut expenses. 
• Establish a new budget. New costs will inevitably arise after you purchase the home, including upkeep, general maintenance and yard care. Be sure to account for these new expenses in your updated budget. 

While there are general guidelines that can help you determine the amount of home you can afford, you can get a more accurate idea by understanding the specific factors that lenders take into consideration when qualifying buyers for a home. 

Buying a home is exciting, but it’s important to check all your boxes to make sure you’re prepared for homeownership. Potential homebuyers can better prepare for getting approved for a mortgage by being intentional about setting financial goals.