How Much House Can You Afford?

Buying a house can be one of the most stressful experiences in life, especially when you're going through the process for the first time. There are so many decisions to be made, from major (choosing a neighborhood) to minor (selecting paint colors).

For most first-time home buyers, however, the very first question on their minds is, "How much can I afford?" Thankfully, there's a straightforward answer to that question.

Determine your total house payment

One mistake many home buyers make is determining how much they can afford based on the mortgage payment alone. A better figure to base your decision on is your total house payment:

• Mortgage + property taxes + homeowners insurance + PMI = total house payment

Your property taxes will vary depending on the city and county in which you purchase your home. Here are a few tips for getting your total house payment as low as possible:

• Ask your realtor about the property tax rates throughout your county to see if there's a desirable area with a lower rate.
• Shop around to find the best deal on your homeowners insurance.
• Cut PMI out of the equation by putting down 20% or more on your home.

PMI, or private mortgage insurance Opens in a new window, is insurance that the bank makes you pay to protect it against the possibility of you defaulting on your home loan. If your down payment is at least 20% of the sale price of your home, the bank considers you less of a risk and doesn't make you purchase PMI.

Figure out what you can afford

Very simply, the answer to this question comes down to how much you make and how much you owe.

After the housing crisis in 2009, Fannie Mae and Freddie Mac set guidelines for lenders Opens in a new window to keep a home buyer's total house payment and total debt to conservative levels. Since then, they say you should not spend more than 36% of your pretax income on your total home payment and that your total debt (including student loans and other debt) should amount to no more than 45% of your pretax income:

• Your pretax income × 0.36 ÷ 12 = total house payment

For example, let's say you make $100,000 a year before taxes are taken out. Your total house payment per month would be $3,000, which would be within the parameters laid out by Fannie Mae and Freddie Mac.

When you factor in your other debt from credit cards, student loans, car loans and any other loans you have, your amount of debt should not exceed 45%. In our example above, that looks like this:

• $100,000 × 0.45 ÷ 12 = $3,750 (total debt)

The above figures are based on relatively conservative guidelines. However, some argue Opens in a new window that your total home payment should not exceed 25% of your pretax income and that your total debt should not go above 43% of your pretax income.

Ultimately, you should limit your total house payment and total debt payment per month to as little as possible while still allowing you to live relatively comfortably.

Many sites offer mortgage calculators that make it fast and easy to see how much house you can afford by doing the math for you. Realtor.com's Home Affordability Calculator Opens in a new window is one helpful example.

Meet a few first-time home buyers

Let's break this down and make it easier to understand with a few scenarios of first-time home buyers so you can begin to see how to make these calculations work for you.
 

Single Sam

Sam is a young professional who graduated college several years ago. He's been paying down his student loans, saving up for a small down payment and feels he's ready to stop renting and buy his first home. He's also saved up $5,000 and put it into an emergency fund to handle unexpected expenses and home maintenance and repair costs. Here's how Sam stacks up:

• Pretax Income: $45,000 per year
• Debt: $400/month ($25,000 in student loans and credit card debt)
• Down Payment: $4,000

If Sam wanted to keep his total house payment to 25% or less of his pretax income, he'd be able to afford a $75,900 house. If he went up to 36%, he could afford a house worth $129,800.

Legal Lisa

Despite the long hours, Lisa enjoys her position at the law firm. She's been making a good income for several years now and is ready to buy. Here are her numbers:

• Pretax Income: $180,000 per year
• Debt: $700/month ($40,000 in student and car loan debt)
• Down Payment: $15,000

Lisa can afford a $415,600 house and keep her total house payment at 25% of her pretax income or push it to 36% with a $636,200 home.

Growin' Gary and Gwen

Gary and Gwen are starting a family, and they're ready to buy their first home. They've worked hard to pay off their student loans and credit card debt. Here's what they can afford:

• Pretax Income: $86,000 per year
• Debt: $300/month ($10,000 left on their car loan)
• Down Payment: $7,500

This young family can afford a $203,600 home and keep their total house payment at 25% or move into a $309,000 home and keep their payment at 36%.

Finding the home that's right for you

Income, debt, and down payment are the three primary factors when figuring out how much home you can afford. However, the interest rate on your mortgage can make a big difference too.

Put yourself in the best situation possible by being honest about what you can afford, not trying to buy more than you are comfortable with, and selecting a trustworthy realtor to show you houses in your price range.

John Schmoll writes about investing, budgeting and frugal living. He is a father, husband, and veteran of the financial services industry who's passionate about helping people find freedom through frugality.

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