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"Can I really afford to buy a house?" I remember asking myself that same question. The mix of excitement and anxiety is real, especially when you're on the edge of a huge money move. What I've picked up is that it all starts with understanding how much money you bring in monthly, and then seeing how it measures up against your expenses, such as student loans, credit cards, and car payments.
Well, that's just the tip of the iceberg, but there's a lot more ground to cover. Stick with me, and we'll go through it all.
How to calculate your budget for a new home?
Let me break it down in simple terms step by step for you, so you don't sweat it if math isn't your thing - I'll make sure it's crystal clear.
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1. Calculate 25% of Your Take-Home Pay
Here's the deal: You should never spend more than 25% of your monthly take-home pay on mortgage payments. That means adding up your monthly paycheck and multiplying it by 0.25. For instance, if you bring in $10,000 a month:
$10,000 × 0.25 = $2,500
Stick to this number, and you'll have enough wiggle room in your budget for other stuff, like saving for retirement or your kids' college fund.
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2. Use a Mortgage Calculator
Now, let's figure out how much house you can afford and how much to stash away for a down payment. You could crunch the numbers yourself, but why bother? Try KreditSanta’s free Mortgage Calculator instead. It lets you play around with different mortgage amounts, interest rates, and down payment options until you find what fits your budget.
⭐Don't forget - Shoot for a down payment of at least 20% to dodge private mortgage insurance (PMI) and slash your monthly payments.
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3. Estimate Your Closing Expenses
Saving for a down payment is just the start. You've also got closing costs to cover, like appraisal fees, home inspections, and loan origination fees. On average, these add up to about 3 - 4% of your home's purchase price, and you'll need to cough up the cash on closing day. So, start socking away those savings!
👉Remember:The bigger your down payment, the less you'll owe on your mortgage.
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4. Include Ownership Expenses in Your Budget
Owning a home means shelling out cash for more than just your mortgage. You'll need to budget for things like higher utilities, repairs, and any upgrades you want to make. That's why it's crucial to have an emergency fund worth 3 - 6 months of your typical expenses before you buy.
So, when you're working out how much house you can afford, don't forget to include saving for emergencies in your plan.
🔔Quick Reminder - The 28/36 Rule for Home Affordability
Here's a simple rule to remember when figuring out "how much house can I afford." It's called the 28/36 rule. Basically, you shouldn't spend more than 28% of your monthly income on housing finances and no more than 36% on all your debts, like mortgage, credit cards, and loans.
For example, if you bring in $4,000 each month and already pay $500 towards other debts, your mortgage payment ideally shouldn't go over $920.
Just keep in mind, while this rule is a good starting point, it's essential to look at your whole financial picture before deciding on a house.
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5. Factor in additional expenses:
Don't forget, your down payment is just one piece of the puzzle. You'll also need to budget for closing costs, which typically range from 2% to 5% of the home's purchase price. Make sure to consider these costs when planning your overall savings goal, as we'll explore in more detail in the upcoming sections!
How does your DTI ratio influence what you can afford?
As a first-time homebuyer, your Debt-to-Income (DTI) ratio is a big deal when it comes to figuring out how much house you can swing. Let's break it down without the jargon:
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➙ Getting a Handle on Your DTI Ratio
Your DTI ratio compares your monthly debt payments to your gross monthly income. It helps lenders assess your ability to manage monthly payments and is divided into two types:
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Front-End DTI: This includes your housing finances like mortgage, property taxes, insurance, and HOA fees.
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Back-End DTI: This encompasses all your monthly debt payments, including housing costs, plus any other debts like credit card bills, student loans, and car payments.
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➙ Why Your DTI Ratio Matters
DTI ratio gives lenders insight into your financial health and determines how much they're willing to lend you for a mortgage. Here's why it's essential:
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Risk Check: Lenders look at your DTI ratio to see if you're likely to pay them back. The lower your DTI, the better.
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Loan Approval: Most lenders have a max DTI they'll accept. If yours is too high, you might not get approved for a mortgage.
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Affordability Impact: A high DTI means a big chunk of your paycheck goes toward debt, leaving less for your home.
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➙ Calculating Your DTI Ratio
While the magic number varies, lower is always better. Here's a ballpark:
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Add up all your monthly debt payments.
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Divide your total debts by your monthly income (before taxes).
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Multiply the result by 100.
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➙ The Ideal DTI Ratio
A lower DTI ratio generally indicates better financial health and more affordability. Here's a rough guideline:
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Front-End DTI: Aim for 28% or less of your gross monthly income.
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Back-End DTI: Ideally, keep this below 36% of your gross monthly income.
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➙ Managing Your DTI Ratio
Want to improve your DTI ratio and afford more? Here's how:
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Slash Debt: Pay down what you owe to lower your monthly payments.
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Boost Income: Look for ways to make more money, like asking for a raise or picking up a side gig.
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Reassess Goals: If your DTI is sky-high, rethink how much house you can realistically handle or hold off until you're in a better spot financially.
Understanding your DTI ratio gives you a leg up in the home-buying game. Keep it in check, and you'll be on your way to affording that dream home in no time.
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The impact of loan selection on your budget
Picking the right loan can really change how big of a home you can buy. Let's go over what each one means for your wallet.
If you decide on an FHA Loan -
With an FHA loan, you'll face two main costs:
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There's an extra expense upfront called up-front mortgage insurance.
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On top of that, you'll also have to pay monthly mortgage insurance premiums
If you opt for a VA Loan -
VA loans, backed by the Department of Veterans Affairs, offer some advantages:
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You won't need to make a down payment.
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Unlike FHA loans, there's no need to pay for mortgage insurance.
However, there's still a funding fee with VA loans, so you should account for that in your budget.
If you go with a Conventional Loan -
Here's what to expect:
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If you put down less than 20% with the Conventional Loan, you'll have to pay for private mortgage insurance (PMI).
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The cost of PMI varies based on factors like your lender, down payment, and credit score. Typically, it falls between 0.58% and 1.86% of the total loan amount.
If a USDA Loan is your choice -
USDA loans, supported by the U.S. Department of Agriculture, come with their own set of considerations:
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There are both upfront and annual fees.
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These fees will lower the amount of home you can afford.
What income do you need for a $400,000 home?
Let's apply what we've learned with a different scenario. Suppose you're eyeing a $400,000 house. Firstly, you'll need to diligently save up $80,000 in cash for a 20% down payment. If you're already a homeowner, ensure you have sufficient equity to cover your down payment when selling your current property.
Now, let's consider a 30-year mortgage at a 4.5% interest rate. Your monthly payment, covering only principal and interest, would be approximately $1,611. To comfortably manage this payment, you'd ideally need a monthly take-home pay of at least $6,444, as $1,611 is 25% of $6,444.
So, to afford this $400,000 home, your annual take-home salary should exceed $77,328 ($6,444 x 12 months). Remember, this figure may need to be higher once you include property taxes and home insurance costs.
That doesn’t sound as good as you think? Take a breath. You've got choices.
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Save more upfront for a down payment. This can help lower your monthly mortgage payment.
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Look into smaller homes in neighborhoods with lower prices.
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Consider different mortgage options or financial assistance programs.
What elements influence the answer to "how much house can I afford?"
Let’s have a look at the key factors that play into determining affordability -
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Earnings: This refers to the money you regularly earn, like your salary or income from investments. Your income sets the foundation for what you can comfortably afford to pay each month towards a mortgage.
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Savings Buffer: These are the funds you have available to put towards a down payment and cover closing costs. You can use savings, investments, or other accessible sources of money to fulfill these expenses.
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Debt Load: This includes all your monthly financial commitments such as credit card payments, car loans, student loans, groceries, utilities, and insurance premiums. Understanding and managing these obligations is crucial in assessing your affordability.
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Credit History: Your credit score and existing debt play a significant role in how lenders evaluate your borrowing capability. A strong credit profile can result in better borrowing terms, including the amount you can borrow and the interest rate you'll receive on a mortgage.
Is it smart to buy a home now or to wait?"
Let’s have a look at the key factors that play into determining affordability -
If this question has crossed your mind as well, you're likely wondering if homes or mortgages will become more affordable soon, or if your financial situation will improve. However, the truth is, there might never be a perfect time to buy a home or a perfect home to buy.
Here are some signs that now could be a decent time to buy:
✅You can comfortably manage mortgage payments, insurance, and taxes.
✅You're okay with covering mortgage insurance and homeowners association fees, if applicable.
✅Your job is stable, and there's no immediate threat of losing income.
✅You don't anticipate a sudden spike in expenses.
✅You're planning to stick around for at least five years.
✅Your savings won't be wiped out after covering your down payment, closing costs, and moving expenses.
✅You're prepared - whether it's with time, skills, or money - to handle home maintenance and repairs.
On the flip side, here are some reasons you might want to hold off:
❌Your budget is stretched thin, even with a mortgage approval.
❌There's chatter about layoffs at work.
❌You're carrying a hefty load of consumer debt.
❌You're considering a move for work, a relationship, or just a change of scenery.
❌Your emergency savings are less than three months' worth of expenses.
❌You're feeling maxed out and can't take on any more responsibilities right now.