How to Determine How Much House You Can Afford: A Comprehensive Guide by O1ne Mortgage

Buying a home is one of the most significant financial decisions you’ll ever make. With the median sales price of U.S. homes reaching $417,300 in mid-2024, according to the Federal Reserve, it’s crucial to understand how much house you can afford. This guide will walk you through the steps to determine your home affordability, calculate your monthly payments, and improve your chances of securing a mortgage. For personalized assistance, call O1ne Mortgage at 213-732-3074.

How to Determine How Much House You Can Afford

To determine how much house you can afford, you need to estimate your monthly payments and see how they fit into your overall financial plans and budget. Here are four steps to get the information you need:

1. Gather Your Data

You’ll need some basic information to start. Be as precise as you can, but estimates are fine if you’re just trying to get a general sense of how much house you can afford. Here’s what you’ll need:

• Home price
• Down payment
• Mortgage amount
• Interest rate
• Loan term
• Mortgage insurance
• Property taxes
• Home insurance
• Income (yours and your co-borrowers’)
• Credit score

2. Calculate Your Monthly Payment

Using a mortgage calculator, estimate your monthly payment based on the home price, down payment, interest rate, and loan term. If you’d like, use the advanced option to add in costs for property taxes, home insurance, mortgage insurance, and any homeowners association (HOA) fees that may apply. Both you and your lender will want to assess whether monthly payments fit your income and budget.

3. Consider How Much You Can Borrow

Lenders look at a variety of factors when deciding whether to approve a loan. They’ll examine your income, credit score, outstanding debts, down payment, cash reserves, and more. It can be difficult to predict exactly how much loan you’ll qualify for and what your interest rate and loan terms will be.

One way to get more clarity is to have a lender preapprove you for a loan. You’ll supply income information and agree to a credit report; they’ll provide a loan offer that shows your rate so you can figure out more accurately what your monthly costs would be.

4. Strategize

Once you know how much money you have to put down and how much you can borrow, you’ll have a fair idea of how much house you can afford. If needed, you can look for ways to increase your down payment, boost your credit, or shop for a less expensive house (or a more favorable loan) to improve your prospects.

How to Calculate Your Monthly Payments

You can use a mortgage calculator to estimate your monthly payments. Here’s what you’ll need:

• Home price: Enter the price of a home you want to buy or start with a typical price for a home in your neighborhood.
• Down payment: Include money you’ve saved toward a home purchase, gift money you may have received, and proceeds from the sale of your current home, if you’re planning to move up.
• Loan term: You can choose to pay off your mortgage in 10, 15, 20, or 30 years. Selecting a longer loan term may reduce your monthly payment, but it may increase the total amount of interest you pay over the life of the loan.
• Interest rate: Interest rates can vary from lender to lender and loan to loan. They may also change based on economic factors or even your credit score. Check your bank’s website or an online marketplace for typical interest rates on home loans.

Example: Say you want to buy a home that costs $370,000 with a 20% down payment of $74,000. A 30-year mortgage at 6% interest breaks down to monthly loan payments of $1,774.67. Payments on a 15-year mortgage would be $2,497.82. If you found a 30-year mortgage at 5% instead, your monthly payments would be $1,588.99.

What Else Determines Home Affordability?

You can fine-tune your results by adding in projected costs for common monthly expenses. Use the mortgage calculator’s advanced options to factor in these typical home-related expenses:

• Property taxes: Depending on your home’s assessed value and tax laws where you live, property taxes can add hundreds or thousands of dollars to your monthly housing costs.
• Home insurance: Home insurance covers liability and damage to your home from events such as fire, windstorms, or theft. Although you may not be required by law to carry homeowners insurance, your lender may require it.
• Mortgage insurance: If your down payment is less than 20% of your home’s purchase price, you may have to pay private mortgage insurance (PMI) to cover the difference between your down payment and the conventional 20% down payment amount.
• HOA fees: If you buy a condo or a home in a development with a homeowners association, you may have to pay HOA fees for common costs, such as maintenance and insurance for the community.

How Much Mortgage Do I Qualify For?

Lenders consider your down payment, income, debts, credit, cash reserves, and home value when deciding how much they’re willing to lend. Here’s a quick list of factors lenders consider when evaluating your loan application:

• Income: A steady, stable income demonstrates your ability to repay. As a simple guideline, lenders may limit your loan amount so that monthly housing costs don’t exceed 28% of your gross (pretax) income. If you make $10,000 a month, that’s $2,800 in monthly mortgage, property tax, home insurance, HOA, and PMI payments.
• Debts: Additionally, your housing expenses plus monthly debts (credit card payments, car loans, student loans, and personal loans) should not exceed 36% of your gross income—43% for some lenders.
• Credit: Most loan programs have a minimum credit score requirement and, in general, higher credit scores will also secure better interest rates. Lenders also review your credit report to look for late payments, high credit utilization, recent credit applications, and major negatives (such as bankruptcies).
• Down payment: Although there are loan programs that let you borrow with zero down payment, most loans require at least some money down. If you can provide 20% of your home’s purchase price as a down payment, you can usually avoid the additional cost of PMI.
• Cash reserves: Having at least three to six months’ worth of expenses in reserve shows lenders that you can pull through a minor emergency without missing a payment.

Get Preapproved for a More Accurate Estimate

The complex interplay between your income, credit, debts, and assets can make it difficult to know exactly where you’ll land when you apply for a loan. If you’re ready to start home shopping, consider getting preapproved. By putting the application and approval process first, you’ll find out how much loan you qualify for before you begin looking. You can apply for preapproval online with many lenders. Not only is preapproval necessary for you to get a better understanding of your loan limits and estimated monthly payments, but many home sellers won’t even look at offers without a preapproval letter.

How to Improve Home Affordability

What if your calculations don’t match up with housing prices in your area? Try changing your parameters to see whether you can increase your buying power or lower your costs. You may need to pause and focus on saving more money, improving your credit, or looking outside your current neighborhood. Here are a few ideas for changing the dynamic:

Improve Your Credit

A higher credit score may help you qualify for a better interest rate and loan terms. Maintaining a solid history of on-time payments, for example, could help boost your credit score over time. Negative information that appears on your credit report, such as late payments, collection accounts, or bankruptcy, are removed from your credit reports after seven years.

Pay Down Debt

High credit card balances, auto loans, and student loan debt affect your debt-to-income ratio—and your ability to secure a mortgage. Paying off a car loan or credit card balance may help you qualify for a mortgage; it may also help raise your credit score by improving your credit utilization.

Increase Your Down Payment

A bigger down payment directly increases your buying power. It may also help you qualify for a bigger loan—or reduce the amount you need to borrow. Taking an extra six months or a year to save up could put you in striking distance of the home you want.

Look for a Lower Interest Rate

Interest rates can vary from one lender to the next, and over time as interest rates fluctuate. Even a small change in APR can translate to significant savings on your monthly payment: Saving 0.5% on a $300,000, 30-year loan could save you nearly $100 per month.

Consider a Less Expensive Home

Setting your sights lower could be the ticket to finding a home you can afford. Consider a smaller house, condo, or townhome, or look for a home in a less expensive area. If you’re confident in your home renovation skills, you might think about buying a fixer-upper and using sweat equity to create a home that’s personalized to your taste.

Boost Your Income

If your income is limiting your ability to secure the mortgage you need, finding a better-paying job, going after a promotion, or starting a side hustle might improve your prospects. Adding a co-borrower, such as your spouse or partner, to your loan application adds income for your lender to consider.

Frequently Asked Questions

• How Much House Can I Afford With an FHA Loan?
• How Much House Can I Afford With a VA Loan?
• What Is the 28/36 Rule?
• How Much Should I Spend on a House?

The Bottom Line

Before you apply for a home loan, check your credit report and FICO® Score to get a clear view of what lenders will see as they review your loan application. Taking the time to fully understand your options is the first step in determining how much house you can afford. Once you know what a loan will cost and whether you’re likely to qualify, you can start looking at homes that fit your budget.

For personalized assistance and to explore your mortgage options, call O1ne Mortgage at 213-732-3074. Our team of experts is here to help you navigate the complexities of home buying and secure the best mortgage for your needs.