Use this guide to determine how much you can afford to pay for a home. To figure out what home you can afford, let’s take a look at the various factors your bank uses to determine your loan amount. We’ll also explain the costs of home ownership and how to use your monthly budget to help you calculate a comfortable loan amount.
Use a mortgage calculator to get a general idea of how much you can borrow based on your income and expenses.
How Do Banks Decide How Much to Lend You?
All banks base their decisions on the same basic factors:
- How much money you make.
The more money you bring home every month, the more you’ll be qualified to borrow.
- The value of the home you choose.
The home you purchase will be used as collateral. The house becomes property of the bank if you don’t repay your loan.
- Your other debts.
The amount of debt you carry on credit cards and revolving charge accounts will impact how much additional credit a lender is willing to extend to you.
- Current interest rates.
When rates are low, it costs less to borrow the same amount than it would at a higher interest rate.
- Your credit score.
Banks use your credit score to predict how likely you are to repay your loan.
How Do You Decide How Much to Borrow?
Your mortgage payment will be one of your biggest expenses. To figure how much you can comfortably borrow, consider:
- Your income.
Do you expect your income to remain stable or increase?
- Your monthly budget.
Will your current income and expenses allow you to take on the responsibility of a mortgage and the additional monthly expenses that come with homeownership?
- Your savings.
Do you have money saved to cover the down payment (typically ranges between 3.5% to 20% of the cost of the house), mortgage origination fees (usually 1% of the purchase price) and the closing costs (generally 2% to 4% of the purchase price) and still keep the monthly mortgage payment within your budget?
Rule of Thumb for What You Can Afford
You’ll hear different advice on what you can afford to borrow depending on who you ask, but a good rule of thumb is to keep to these limits:
36% goes to pay debts.
Banks generally advise that your mortgage payment not be more than 28% of your monthly income, leaving 8% for other debts like a car loan.
31% of your income goes toward taxes.
That’s the national average.
33% goes toward everything else.
Food, clothes, entertainment, vacations, savings and investments that you put away for a rainy day.