Buying a home is an exciting time and process, but knowing how much you can afford to spend is not always easy. Calculating how much home you can afford before you start looking helps you to understand your budget, how to create your wants and needs list, and what neighborhoods you should consider calling home.
How Much Home You Can Afford: Calculate Your Down Payment
The first step in determining how much home you can afford is to calculate your down payment abilities. If you have been saving for a down payment for a while, you are likely in better shape than going without a down payment saved at all.
The general guideline is to save 20% for a down payment when purchasing a home. This helps you avoid costly private mortgage insurance (PMI) and improves your chances for approval for a mortgage loan.
Bankers like to see that the buyer has skin in the game and putting down a sizeable down payment is evidence to that. Some banks will not approve a mortgage without a 20% down payment, but some will go down to a much lower level if you have a solid credit history and qualify for special loans through the VA or FHA.
How Much Home You Can Afford: Calculate Your Monthly Housing Budget
How much are you currently paying for your rent or mortgage, and what can you afford in the future? That is the next question to answer.
If you already keep a budget each month, you can simply pull up your budget and look at your mortgage and rent line and any other disposable income you can and want to funnel into housing costs each month. Remember that being house poor isn’t any fun and is not always sustainable, so don’t stretch your budget too far.
Next, using a mortgage calculator, you can back into a loan amount you can afford. Estimate property taxes and homeowner’s insurance, and deduct that from the monthly payment before you enter your monthly budget into a mortgage calculator.
A $1,000 monthly budget qualifies you for a loan around $209,000, a $1,500 monthly budget qualifies you for around $314,000, and a $2,000 monthly budget qualifies you for around $418,000 assuming a 4% interest rate.
How Much Home You Can Afford: Combine the Two for an All-In Budget
Now that you know your down payment and your monthly budget, you can estimate how much home you can afford. Just add the two numbers together for a basic estimate.
If you have a $20,000 down payment saved and can afford a $1,500 monthly payment, you can afford a home that costs around $334,000 dollar, for example.
While you sometimes can stretch your down payment to qualify for a home at less than a 20% down payment, you can’t stretch your monthly budget, so that is your biggest limiting factor.
If you have a much bigger down payment, you can easily see how that can translate to affordability to a more expensive home. If you can put down $200,000 instead of $20,000 but still have a $1,500 monthly budget, you can afford a $534,000 home instead of a $334,000 home. That is a big difference!
If you don’t have a down payment saved, there is no better time to start saving than the present. Then you can save up until you reach a point where you can afford a great starter home, and eventually a dream home not too far down the road.