How much house can I afford? How to plan for monthly and upfront costs

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• To determine how much house you can afford, think about your monthly payments and upfront costs.
• A general rule of thumb is that you should spend 28% or less of your monthly income on housing costs.
• Consider how much you’ll be approved to borrow, and factor expenses like the mortgage, homeowners insurance, and property taxes into your monthly payments.
• Figure out how much you can afford for a down payment and closing costs, and decide how much savings you want to have left over once you’ve bought the house.
• Policygenius can help you compare homeowner’s insurance policies to find the right coverage for you, at the right price »

To figure out how much house you can afford, look at two types of expenses: the amount you’ll spend on your home each month, and the amount you’ll pay to buy it in the first place.

You might think these two numbers just break down into how much you’ll spend on your mortgage and down payment — but there’s a lot more to it than that.

When buying a house, the general rule of thumb is that you should spend 28% or less of your monthly income on housing expenses. This includes your mortgage payments and any other monthly house-related expenses, such as insurance, taxes, and homeowner’s association dues. 

To calculate what 28% of your monthly income is, multiply your monthly income by 0.28.

Let’s say your monthly income is $4,000. Multiply $4,000 by 0.28, and your total is $1,120. If you abide by the 28% rule, then you can afford to spend up to $1,120 per month on your house.

Your mortgage will make up the bulk of your monthly payments, so it’s crucial to think about how much you will borrow. Before approving you for a home loan, a lender looks at your financial profile. It examines three main factors: down payment, credit score, and debt-to-income ratio. 

The stronger your finances are, the more money the company will loan to you.

If you want a $200,000 mortgage but your lender won’t approve you for that much, then you can’t afford a home that requires a $200,000 loan. You’ll either need to change your finances or lower your homebuying budget.

Here are the down payment, credit score, and DTI you’ll need to get a mortgage, and some suggestions for improving them so you can borrow more.

Down payment amount

You’ll need at least 10% toward a down payment for a conventional loan, or 3% if the conventional loan is backed by government-sponsored mortgage companies Freddie Mac or Fannie Mae.

An FHA mortgage requires a 3.5% down payment. If you qualify for a loan backed by the VA or USDA, then you might not need a down payment at all.

These are the minimum down payments required. But if you have more for a down payment, then you could be approved to borrow more. (And at a lower interest rate!)

Credit score

For a conventional loan, you’ll need at least a 620 credit score. 

You’ll want a 580 credit score for an FHA loan and 640 for a USDA loan. The required score for a VA loan will depend on your individual lender.

But the higher your credit score, the more you could be approved to borrow.

Improving your credit score can take a little time, but it’s not too difficult if you know the steps to take. The most important factor is making all your payments on time. Try setting up automatic payments on all your bills so you’re never late.

Another big part of your credit score is your amount owed, or the percentage of your available credit you use (you might hear it called the “utilization ratio”). Try paying down some debts or requesting to increase your credit card spending limit so your percentage shrinks — if you honestly believe you can practice self control with a higher spending limit.

Debt-to-income ratio

Your debt-to-income ratio is how much you owe versus how much you earn. To calculate your DTI, add up your monthly debt expenses, like rent, credit card payments, and student loan payments. (Non-debt expenses, like groceries, don’t count.)

Then divide your total monthly debt expenses by your monthly income. For example, if you pay $1,000 per month toward debts and earn $4,000 per month, you’ll divide 1,000 by 4,000 for a total of 0.25. Your DTI is 25%.

Conventional mortgages typically allow a minimum DTI of 36%, but the ratio can be a little higher for FHA, VA, and USDA loans. You might be able to get a mortgage with a higher DTI if you have an excellent credit score, though.

The lower your DTI is, the more your lender may approve you to borrow. To lower your DTI, you could pay off a credit card or refinance student loans for lower monthly payments, if doing so would be a strong financial move overall.

If your monthly housing costs total more than 28% of your income, then you may want to take out a smaller mortgage, or find a home that comes with fewer fees. Here are the housing costs to consider:

Mortgage payment

Your mortgage payment will be your most significant housing cost each month. The amount you pay per month will depend on a) how much you borrowed, and b) your interest rate.

Property taxes

Property taxes can come to hundreds or even thousands of dollars per year.

The amount you pay in property taxes largely depends on where you live. For example, you may pay less in Arkansas than in North Carolina — but you’ll also pay less in some parts of Arkansas than others. Property tax costs also rely on the assessed value of your home. The more your home is worth, the more you’ll pay in property taxes.

Homeowners insurance

Homeowners insurance protects you should something go wrong. Maybe a tornado damages your house, or a thief breaks in and steals valuables, or a tree falls on the roof.

The average annual cost of homeowners insurance in the US was $1,211 in 2017, according to the National Association of Insurance Commissioners. Your payment will depend on factors such as the age of your home, estimated value of the home, and where you live.

Private mortgage insurance

While homeowners insurance protects you and your home, PMI protects the lender should you default on your mortgage payments.

You’ll need PMI if you have less than 20% for a down payment on a conventional mortgage. The lower your down payment, the bigger risk the lender considers you to be. PMI helps offset that risk.

Keep in mind that PMI is only for conventional mortgages. This means you don’t need PMI if you have a government-backed loan — including an FHA, VA, or USDA loan.

PMI typically costs between 0.2% and 2% of your mortgage amount, according to insurance-comparison website Policygenius. The cost will depend on your loan term length, loan-to-value ratio, and credit score.

Homeowner’s association dues

A homeowner’s association (HOA) is a private organization that maintains the quality of a neighborhood. Not all neighborhoods have HOAs, but if you move into an area with an association, then you will pay dues and be expected to follow HOA guidelines.

Depending on where you live, HOA dues can cost you up to a few hundred dollars per month.

Real estate websites like Zillow and Trulia list homeowner’s association dues on a home listing. This can be a quick way to find out if a fee is too high for your budget.

Yes, calculating your monthly payments is important. But you should also think about how much money you can afford to pay during the homebuying process. Here are three factors to consider:

Down payment 

This is probably the upfront cost people think about the most. Do you have the minimum down payment amount your type of loan requires?

You’ll need 10% for a conventional mortgage, 3% for a conventional mortgage backed by Freddie Mac or Fannie Mae, and 3.5% for an FHA loan. You might not need any down payment for a USDA or VA mortgage.

Closing costs

Don’t forget to factor closing costs into your budget. Closing costs include expenses like an application fee, appraisal fee, and settlement fee. Some lenders require you to pay some property taxes at closing, while others let you wait until your first monthly payment.

According to mortgage technology company ClosingCorp, the average closing costs in 2019 were $5,749 including taxes, or $3,339 without taxes.

How much savings do you want to have left over?

You probably don’t want to drain 100% of your savings to buy a home, only to find yourself in a bind if a financial emergency occurs. Think about how much money you want to have left in savings once you’ve made the down payment and covered closing costs.