Whether you are a first-time home buyer or a fifth-time home buyer, the first question you need to ask yourself is, how much house can I afford? The steps we'll cover in this home buyer's affordability guide can help you answer that question.
Having a clear picture of your finances is the key to home affordability. When you take the time to find out how much home you can really afford, you’ll quickly discover that it’s much easier to make many of the subsequent decisions that will come up, like when and where you'll buy your first or next dream home. Check off each of these steps and you’ll be ready to make that big home investment leap.
Determine Your Total Annual Income
The first item on your 'how much house can I afford' checklist is to determine your annual income for the previous full year accurately. To do that you find the sum total of your monthly gross income, before taxes or other deductions. Next, add any potential future bonuses you might expect to receive and/or any other income sources you may have to the sum total of your monthly gross income—that number is your total annual income.
If you are buying the house with a spouse or partner, for example as joint tenants, or with another person, perhaps as tenants in common, add their annual income as well to determine your combined sum total annual income.
Learn Why Prequalification Matters
Why should you determine your total annual income? Because when you’re ready to shop for a home it’s best to get prequalified. Annual income affects how much home you can qualify for-- a mortgage lender looks at your complete financial picture and qualifies you for a mortgage based on that picture. In addition to annual income, a lender will look at the savings you have and what debts you owe. You are prequalified or preapproved for a loan based on all of those numbers.
Calculate Your Down Payment
In this step determine the total amount of money you can put down on a home purchase. Home affordability should not lead to home impoverishment, so don’t commit all of your funds to your down payment. You must protect your financial health from unforeseen hits to your income during and after the home buying process. Lenders typically want a 20% down payment to buy a home, but if that’s a high hurdle where you are looking to buy, shop around. Many lenders have options and can work with you to find the right loan, depending on your credit score and other factors.
Calculate Your Expected Mortgage Payment
Home loan calculators abound online and are great tools for assessing your likely monthly mortgage payment. Simply type 'home loan calculator' into your favorite browser and you'll find plenty of options! It’s also a good idea to shop around to find the best mortgage rates. If you search online using terms like ‘compare current mortgage rates,’ you can review the published rates from many home loan companies. You just plug in data such as a zip code for the area in which you’re house hunting, as well as purchase price, down payment amount and percent, and loan term.
The payment will depend on the current interest rates for that day (and remember, they fluctuate constantly), your down payment amount, the term of the loan, and other factors. Be sure you account for homeowner insurance payments, property taxes, escrow funds, and potentially, mortgage insurance to accurately determine your payment calculation.
Understand Typical Closing Costs in Your State
Do research in your area on typical closing costs in dollars. Closing costs may include appraisal and inspection fees, underwriting, processing, and application fees, report costs for credit scores and home inspection, brokerage and attorney fees, and more. You can negotiate these fees, sometimes with your lender, or with the home seller.
Knowing what to expect in closing costs helps you avoid surprises. Nationally, closing costs run between 2% and 5% of the total home purchase price so use that as a guideline as well where you are shopping.
Add Up the Cost of Your Household Bills and Other Debts
Are you paying a student loan? Medical bills? Car payments? Childcare? Many of the monthly bills you pay impact your ability to both get a mortgage and take on a mortgage payment. Knowing the total sum of your current debts, and forecasting future potential debts can help you be realistic about how much home you can afford, and help in prequalifying you for a loan.
Do You Have Savings to Use for Repairing Home Systems and Appliances?
Have you been renting a place with someone, or maybe saving up a down payment by living with your parents? If so, you may not have had to deal with the hassles of an appliance or home system breakdown and/or paying the often costly repair bill. Keep in mind that everything you calculate as money you need before your home purchase doesn’t help if you can’t afford to pay to fix something after you move into your new home.
When you buy a home you take on the responsibility for finding the right contractors and paying for any problems yourself. Having savings for the unexpected helps, but having a home warranty to cover repair or replacement of covered systems and appliances also helps protect your budget, particularly for first-time homeowners who can be house poor in those first years of homeownership.
If you just bought a home, you can add a real estate home warranty for up to 60 days after your close. Reach out to your real estate agent or get a home buyer’s warranty quote online — it's quick and easy.