Calculate your maximum monthly payment
The first place to look is your potential (usually) monthly home payment. Unlike rent, which is a simple agreement with a landlord, mortgage payments typically comprise several parts:
Monthly payment = mortgage + property taxes + homeowners insurance + (sometimes) PMI + HOA fees
Your mortgage payment (loan principal plus interest) typically makes up the biggest part of your monthly costs. Homeowners are also responsible for property taxes and insurance (which are often tacked on to your monthly mortgage payment), along with potential homeowners association (HOA) and other fees.
If your down payment is less than 20% of the home’s value, you’ll have the added expense of private mortgage insurance (PMI), which kicks in until you reach 20% equity, or how much of the home you own compared to its value. The cost for PMI is usually around 0.5% to 1% of the loan amount per year.
Many mortgage lenders follow guidelines set by national lenders Fannie Mae and Freddie Mac. According to Freddie Mac Opens in new window, the maximum monthly payment can’t exceed 45% of your “stable monthly” (gross) income, but it’s much better to pay less than 33% to 36%. This means that if your household earns $75,000 a year (or $6,250 a month) before taxes, you should target a monthly mortgage payment below about $2,100.
Interest rates are a major factor in your monthly payment and total borrowing cost. Lately, they’ve been historically low—around 3% on average Opens in new window in early 2021—but yours would depend on your credit score and loan details.
Find your top home price
For 2021, the largest mortgage loan Fannie Mae Opens in new window will make for a single-family home in most areas is $548,250. But just because you can get a loan that big (or bigger) doesn’t mean you can afford it. It’s important to look at your down payment and mortgage payment to estimate how much you can buy without becoming “house poor”—that is, having a high house payment that’s tough to keep up with.
Ideally, you‘d put at least 20% down on a home to avoid PMI. In April, the average sale price for homes Opens in new window in the U.S. was $403,600 (it’s a “seller’s” market); 20% of that would mean a $86,720 down payment. Even if you qualify for a 3% down payment (for low-income, first-time homebuyers) offered through Fannie Mae and Freddie Mac, you’d still need to come up with $12,108.
You’re certainly not limited to a 20% down payment—that’s just a minimum to avoid PMI and improve your odds of getting approved for a loan. If you can save up and put down more, your monthly payment will be less.
To find the top of your budget, first add up your down payment and the maximum loan you’d qualify for based on your monthly payment, credit score and other loan terms. But also consider your overall financial picture. (A tool like the FHA U.S. Mortgage Calculator with Taxes, Insurance and PMI Opens in new window can quickly give you an idea of your ceiling based on your annual income, monthly debt payments, down payment savings and other factors.)
If you get a result you don’t like, consider lowering your sights on a home—or think about how you can pay off debts, increase your income or save a larger down payment so you can afford a more expensive place.
Finally, bear in mind that besides your mortgage and down payment, you’ll face a number of upfront expenses when you buy. Inspections, appraisals, credit reporting, town government recording and more can all carry their own fees. In all, expect to pay 2% to 5% of your new home’s value in one-time costs.