Home Affordability

The quick facts about home affordability

Whether you’re a first-time home buyer, looking to up-size to accommodate a growing family, or ready to downsize as you move into empty-nesting, buying a home can be intimidating. Indeed, there’s a lot more to a real estate purchase than just the home price.

Here are a few things to understand before you go all in on a home.

Ready to take the next step and fit home ownership into a financial plan that serves your long-term goals? When free calculators aren’t cutting it any more, a Certified Financial Planning® professional can help.

• Affordability factors: Home affordability depends on complex factors, including location, taxes, loan types, your debt-to-income ratio, insurance costs and your credit score.
• Expenses: Understanding your average fixed and variable expenses over the last 12 months will help you determine the monthly payment that fits with your budget and financial goals, a key factor when choosing your next home and deciding how much house you can comfortably afford.
• Gross income matters: Account for all sources of gross monthly income/monthly pre-tax income, including side hustles, dividends, and alimony, to get a complete picture of your financial situation before determining home affordability. Not sure how all your financial pieces fit together? That’s where a Certified Financial Planner® professional can help.
• Debt's impact on home affordability: Reducing debt increases your ability to afford a home and get better mortgage terms, as it improves your Debt-to-Income ratio, a key variable for lenders, and boosts your cash flow. Minimizing personal and credit card debt before you start the home-purchasing process will help ensure your housing costs and total debt payments are within manageable limits as you determine how much mortgage debt you can reasonably afford to pay.
• Utilizing calculators: Use our home affordability calculator to calculate how much your monthly payments will be based on your financial data.
• Explore different loan types:Some people in unique circumstances may find different loan options available to them. For example, if you can afford a higher monthly payment, a 15-year loan term may offer lower interest rates. On the other hand, certain banks specialize in low down payment loans for particular high earning professions such as doctors. Investigate any unique loan types that may apply to you, such as FHA or VA loans, to find the best fit for your financial situation.

‍

Understanding how much house you can afford

You probably think you have a good grasp on where your money goes—you know what you pay for your current mortgage or rent and utilities, you know your car payment and insurance, and you know how much you pay for student loans, daycare, or tuition.

It’s easy to track big, recurring monthly expenses, generally known as fixed expenses. They don’t change substantially month-to-month, and you know exactly when they’re due. But how much do you pay for gas each month? What about groceries? Dining out? Entertainment?

Taking inventory of how much you spend monthly, including both larger, fixed expenses as well as variable expenses, is vital to understanding the ebb and flow of your finances before you buy a home. Getting a clear picture of your actual budget, not the budget that only includes the big recurring bills but also other monthly debts, is a vital step in the home-buying process and can help determine how much house you can afford.

It’s not all about outputs, though — you need to keep track of your gross monthly or pre-tax income, too. That means everything, not just your weekly or biweekly paycheck. Income from side hustles or dividends, interest earned on savings, and alimony or child support count here as well.

Once you have a handle on your finances, you might be tempted to ballpark what you can afford on a home or how much house you can afford, but resist the temptation and keep crunching those numbers.

If possible, speak to a financial planner or fiduciary who has your best interests in mind before determining how much you can realistically afford.  Or, at the very least, take advantage of our home affordability calculator. Input your annual income and expenses, as well as all the information you have on your dream home: Mortgage loan amount, down payment amount, property taxes, homeowners insurance, estimated mortgage insurance premiums if you’re putting down less than 20%, closing costs if applicable, and your interest rate. Then, you can see estimated monthly payments and get an idea of your housing budget.

‍

The impact of debt on home affordability

Monthly budgets can be difficult to determine. Some monthly expenses are fixed — housing costs, daycare, etc. — and some aren’t. Debt payments are one expense you can eliminate before you buy a home if you work at it. Whether it’s mortgage payments, a car payment, credit card debt, or a personal loan, getting a handle on your debt is a great way to increase your ability to pay for more house.

Many financial planners suggest you follow the 28/36% rule: housing, including insurance and taxes, should be no more than 28% of your total income and no more than 36% of your total monthly debt payments.

The more total monthly debt you have, the less cash you have to spend on your home purchase, and the less likely you are to get favorable terms on your mortgage.

‍

Defining debt-to-income ratio

Debt and credit scores also play a role when lenders determine loan approval. The debt-to-income (DTI) ratio is a tried and true rule lenders use to determine if you’re a risky borrower. The higher your DTI, the less likely you are to get the best mortgage rate. Paying off recurring debt before applying for a mortgage is a surefire to increase your odds of getting favorable terms on your home loan.

Your debt also plays a role in your overall credit score. The more debt you have, the lower your score drops and the less likely you are to get a good rate or qualify for a loan from a reputable lender.

A high debt-to-income ratio can result in a lower credit score. Paying off recurring debt like auto and student loans will have a significant impact, but getting rid of unsecured recurring monthly debt is a surefire way to increase your credit score or improve bad credit and look better to lenders.

‍

Understanding the 28/36 rule

The 28/36 rule is a commonly used principle in personal finance and mortgage lending. It assists individuals in deciding what percentage of their income should go towards housing costs and overall debt responsibilities. This rule is especially handy for individuals who want to calculate the affordability of a home and those seeking to manage their finances effectively or establish emergency savings for unexpected expenses.

‍

The 28% front-end ratio

The front-end ratio of 28% states that no more than 28% of your total monthly income should go toward housing costs, including mortgage payments (both principal and interest), property taxes, insurance for homeowners, and, if applicable, homeowner associations (HOA) fees. For tenants, this includes paying rent and getting renter's insurance.

To determine this, multiply your monthly gross income by 0.28. For example, if you earn $5,000 per month, your maximum housing cost would be $1,400 (0.28 x $5,000).

‍

The 36% back-end ratio

The second part of the ratio, 36%, recommends that total debt payments should not exceed 36% of your gross monthly income. This includes housing costs as well as other monthly debts like credit card bills, student loan payments, car loans, and any other regular debt payments, but does not include other costs or recurring expenses like utility payments.

To figure this out, calculate 0.36 times your gross monthly income. If you earn $5,000 a month, your combined payments for monthly debts should be at most $1,800 (0.36 x $5,000).

This standard ensures that you are not stretching yourself too thin financially. Staying within these parameters increases the chances of maintaining a healthy balance between your income and expenses, lowering financial stress and the potential of loan default.

Many lenders employ this rule as a standard when assessing mortgage applications. Lenders view borrowers who meet these conditions as lower risk, potentially resulting in improved interest rates and loan terms.

Although the rule is helpful, it's crucial to consider personal situations. Living in expensive areas may require allocating more income towards housing costs. On the other hand, individuals with no other debts can easily afford to spend more on housing without feeling any financial pressure.

Moreover, you should consider personal financial goals and life stages. A young professional with a high earning potential may opt to temporarily exceed these ratios, whereas someone close to retirement may focus on decreasing debt below these thresholds.

Monthly income: $9,000.00

Monthly mortgage payment: $1,800.00

Property taxes: $180.00

Homeowners insurance premiums

$90.00

Homeowners association fees: $50.00

Total: $2,120.00

% of household income: 23.56%

Your recommended budget should be a comfortable fit within your overall finances. You should aim to keep housing expenses below 28% of your monthly gross income. If you have additional debts, your housing expenses and those debts should not exceed 36% of your monthly gross income.

‍

The effect of your down payment on house affordability

A mortgage lender will expect you to put money down toward the price of the house. The bigger down payment you can make, the lower your total mortgage amount and, therefore, the lower your monthly payments.

Twenty percent of the purchase price is generally considered the industry standard down payment for a conventional loan. Some types of mortgage loans allow smaller down payments for qualified buyers, but you’ll be stuck with higher monthly payments, so it’s a trade-off. A bigger down payment also makes lenders see you as less of a risk, resulting in better terms and more options.

A higher down payment also means you’ll have higher home equity from the start.

‍

How loan type impacts house affordability

There are a number of loan options and mortgage types out there to help people in different situations realize the dream of home ownership, and several government agencies offer loan programs. If the 20% down payment standard on conventional loans, like a 30-year fixed loan, is outside of your budget, consider a Federal Housing Administration loan. An FHA loan allows qualified buyers to purchase a home with as little as a 3% down payment in some cases, though buyers will generally have a higher mortgage payment to pay each month.

There are price limits on FHA loans, though they’re generous and take into account location and the current housing market. All FHA loans are required to carry mortgage insurance, so make sure you add that into your budget when calculating affordability.

The US Department of Veterans Affairs (VA) provides zero down payment home loans, known as  VA loans, to active duty and retired service people or their spouses at competitive rates and with no upper limit on the home’s price for first-time qualified buyers. The VA loan program doesn’t require private mortgage insurance (PMI) even if you don’t hit the 20% down payment mark, but there is a funding fee you need to consider when doing the math.

In addition to federal government-backed loans, traditional lenders offer a variety of products to appeal to a wide swathe of homebuyers. The most common are conventional loans like a 30-year fixed-rate loan. This type of mortgage spreads your payments out over thirty years, meaning the lowest possible payment, and provides a stable interest rate—the rate you get in the beginning is the rate you have in the end unless you refinance. Some also offer low down payment options.

While a 30-year loan with a fixed rate is the standard, fifteen-year fixed rates, and other shorter-term loans are great options for someone with a larger down payment or who is in a position to pay a higher monthly payment to pay their loan off faster. Shorter loan terms mean a higher monthly cost and affect overall house affordability month-to-month.

‍

The effect of interest rates on house affordability

The housing market is volatile, reacting to even the slightest changes in the economy. Mortgage rates go up and come down based on what’s happening in the wider world. During the height of the COVID-19 pandemic, rates dropped to a 50-year low, leading to high demand from buyers and higher housing prices as sellers saw an opportunity to make more profit on their homes.

Despite the dramatic dip in 2021, they rose in 2022 and 2023 and hit higher interest rates — 7.8% in the fourth quarter of 2023. Home prices came down some as a result, but not to pre-pandemic levels.

This ebb and flow illustrates that while low rates are good if they go low enough, they can lead to higher overall prices, and higher overall home prices mean higher monthly payments. Striking a balance between rate and price is the ideal way to ensure an affordable monthly payment and a reasonable down payment. Watch the market and know where interest rates are going so you can strike while the iron is hot and get the best bang for your buck.

‍

The impact of location on house affordability

Mortgage rates and loan types affect the bottom line, but they aren’t the only factors to consider when determining how much house you can afford. Location plays a crucial role in the real estate market, what your monthly payment will be, and the amount you are able to pay for a home.

Property taxes, homeowner’s insurance, and even which neighborhood you choose (if you choose to be in a neighborhood at all) come into play and have a significant impact on your monthly payment. Metro areas have higher property tax rates than non-metro areas; new construction will generally have a slightly higher property tax and insurance rate than existing homes; homes in neighborhoods are likely to have Homeowners Association fees that, while maybe not rolled into your mortgage payment in all instances, will affect how much you pay monthly for your home.

The specific metro area also matters. Homes in affluent areas, like Silicon Valley, for instance, will have much higher price tags and, therefore, much higher annual property tax and insurance rates compared to metros like Cleveland or Atlanta.

Owning your own home isn't a pipe dream; with a little planning, a little math, and a little knowledge, you can arm yourself with everything you need to purchase a home you can afford with confidence and keep your housing payment within your budget. Remember, affordability isn't just about numbers; it's about finding a comfortable balance between your financial reality, your household income, and your aspirations.

‍

Home Affordability FAQs

How much house can I afford?

Typically, you can afford a house that costs 2.5 to 3 times your yearly earnings. If you make $80,000 annually, you can probably purchase a house that costs anywhere from $200,000 to $240,000. The accuracy of that estimation depends on your debt, down payment, and additional financial variables.

‍

How much house can I afford with a 100k salary?

Usually, with an income of $100,000 per year, you can manage to buy a house valued at around $250,000 to $300,000. The extent of this range may change based on the amount of your debts, how much money you put down as payment, and the interest rates when you buy. Taking into account your overall financial situation and monthly budget is crucial when you determine how much money to spend on a house.

‍

What credit score is needed to buy a house?

‍Typically, a conventional loan requires a credit score of at least 620, but higher scores can lead to lower interest rates. FHA loans could potentially be an option for individuals with a credit score of 500 or lower, although a higher down payment may be necessary in these cases. Having a better credit score usually simplifies and reduces the cost of getting approved for a mortgage.

‍

How much of my income should go towards paying a mortgage?

‍It is advised to allocate no more than 28% of your gross monthly income to your mortgage payment, which should cover principal, interest, taxes, and insurance. Furthermore, it is important that the sum of all your monthly debt payments, including credit cards and mortgage payments, does not surpass 36% of your total monthly income in order to remain financially stable.

‍

How much savings should I have before buying a house?

To steer clear of private mortgage insurance (PMI), make sure to save a minimum of 20% of the home's purchase price for a down payment if you go with a conventional loan. It is also a good idea to set aside money for closing expenses (typically 2-5% of the buying price) and have an emergency fund that can cover three to six months of living costs.

‍

Is it a good idea to put a large down payment on a house?

‍Making a substantial down payment can decrease your monthly mortgage payments, reduce your interest rate, and eliminate the necessity for private mortgage insurance (PMI). This also implies that you will have a higher amount of ownership in your home right from the beginning. Nevertheless, make sure you still maintain adequate savings for unexpected situations and other financial objectives.

‍

‍What are the upfront costs of buying a home?

Initial expenses consist of the initial down payment (usually 3-20% of the house's cost), closing fees (2-5% of the home's price), and potentially an earnest money deposit. Extra expenses may consist of house inspections, costs for appraisals, and relocation costs. These expenses can accumulate, therefore it is crucial to allocate funds appropriately. You should also have funds available for closing costs and other back-end costs.