How Much House Can You Buy?

How Much House Can You Buy?

If you’re like most people, the thought that pops into your mind after thinking about buying a house is “how much home can I provide?” The answer depends upon a number of factors.

With mortgage rates as low as they are now, payments on a home loan are on a par with rent payments. Assuming that you don’t have credit problems or a lot of debt, you should be able to provide a mortgage.

How large that mortgage can be depends upon your income, debts, credit history, and how small or grand a house you want or are willing to settle for.

There are plenty of mortgage calculators on the internet to help you figure out mortgage payments. What’s more difficult to calculate is how much you’re willing to change your way of living in order to own a home, assuming that you have to make any changes. Having a house shouldn’t take priority over your happiness.

To figure out how much home you can provide, write down your monthly budget. Put everything on that list, especially credit card payments, car loan payments, alimony, child sustain, or any other regular monthly debt payments. Don’t forget to write down what you use for food, entertainment, clothing and other expenses.

Now write down your monthly household income before any taxes. Use the income you reported on your latest tax return. If your income has increased considerably since your last return, make sure you have pay stubs or other method to prove to a mortgage lender that your income has increased.

In figuring out how much home you can provide, the first number you need to start with is 28%. This is the percentage of your monthly pre-tax income that most lenders consider to be the maximum you should be paying on a mortgage. Some lenders will go higher than 28%, and some will be lower, but 28% is a good rule of thumb.

If your monthly pre-tax income is $4000, your maximum monthly mortgage payment is 28% of that, or $1120 a month including taxes and insurance.

You also need to take into account your debts, so the second number to keep in mind is 36%. This is the percentage of your monthly pre-tax income that most lenders will consider to be the maximum you should pay for a mortgage payment and other regular monthly debt payments. Again, some lenders will be higher and some lower, but 36% is average.

Using the hypothetical $4000 a month pre-tax income, the total of your mortgage payment and other monthly debt payments should not be over $1440.

Knowing what your house payments can be, we can approximately calculate how much house you can provide. You can later decide how much you’d be happy affording.

From the 36% amount you derived from your monthly income, subtract the regular monthly debt payments. For credit cards, use the minimum monthly payment shown on your statement. After subtracting your monthly debt payments, the amount you have left is what you can provide to pay on a mortgage. For example, assume that, after subtracting your car payment and credit card payment from the hypothetical $1440 amount above, you’re left with $1000.

How much will that $1000 buy in terms of a home? If we assume that you’re going to get a 6% interest rate on a 30 year fixed mortgage, we can use a multiplier of 166.79, which method that $1000 a month will be the payment on a $169,790 mortgage.

But don’t forget your local government. They have to get their cut.

Tax rates vary widely across the country, but 2.1% of the value of the home is close to the national average. This changes our multiplier at a 6% interest rate from 166.79 to 129.11, meaning that $1000 a month will pay for a $129,110 mortgage. If you already know the tax rate in your area, you can use the 169.79 multiplier to get the amount of mortgage you would qualify for, then figure the taxes and readjust until you come close. Use a monthly mortgage calculator to arrive at the final figure.

You’ll also have to pay insurance. A safe number to use for home insurance is .2% of the home’s value. If we use that figure, our multiplier at 6% now becomes 126.39. So, your $1000 a month will now pay for a $126,390 mortgage.

You can use these multipliers to arrive at a monthly payment for any income, based upon a 6% rate on a 30 year fixed.

There’s also the issue of a down payment. A rule of thumb is that lenders will want 20% of the buy price as a down payment, although some lenders will go lower. FHA loans can require a down payment of as little as 3%. If you’re buying a home for the first time, or don’t have much equity in your existing home to use as a down payment, you’ll need to find a way to get a sufficient down payment. You can’t borrow the money for a down payment, but it can be gifted to you.

After you’ve determined how much of a mortgage you can provide, you need to decide just how much you’re willing to pay. Will that $1000 a month payment cut into your entertainment expenses, or expenses for other things that are important to you? If you’re like most people, spending 28% or so of your monthly income isn’t much different than paying rent. If you’re not like most people, maybe a house isn’t for you.

The numbers above are for illustrative purposes. The rate you get on a mortgage may be higher or lower than 6%. Your lender may allow more or less than 36% of your income to go towards your monthly debts.

Unlike renting an apartment, owning a home carries additional costs that can affect your lifestyle. If you want to keep your home in good condition, it’s safe to assume that you’ll need to use at the minimum a associate of thousand dollars a year on items like furnaces, roofs, lawn and garden, repairs, and routine maintenance. You can do it yourself, or you can pay more to have the work done, but you can be certain that you’re going to pay something one way or another.

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