Can you afford to buy a home?
August 31, 2017
This is often the first question that comes to mind when you start considering homeownership. You're not sure what you can afford, or if you can afford it at all.
Well, look no further. We've got finding a ballpark figure down to just six steps, and you don’t even have to do any math. First, we’ll help you gather the information you need. Then we’ll link you to our favorite mortgage affordability calculator, where you'll simply plug in your numbers. If you’ve already got some budget numbers together, it might only take you about 15 minutes.
Why is this calculator our favorite? We see a lot of calculators out there that are too basic to be realistic, while others are too complicated for the just-getting-an-idea stage. We think this one is about right. Plus, it’s pretty.
Ready to get started?
When we’re done, you’ll have a decent sense of your price range — and whether you’ll qualify for a mortgage.
1. How much money do you have to work with?
Before you buy a home, it’s critical that you put together a sound budget. If you haven’t already done that, download our monthly budget worksheet to get started. But for this exercise, you just need four numbers: your monthly housing expense, gross annual income, monthly debt payments, and down payment. Note these numbers now — you’ll plug them into the calculator in a few minutes.
_____ Monthly housing expense
This is how much you can reasonably spend each month on housing. What are you paying right now in rent? Would you be comfortable paying more? Do you want to be paying less? Comfortable is the key word here. Remember that as a homeowner, you’ll need to continually save for ongoing maintenance and repairs, and chances are, you’ll still want to go out for sushi burritos once in a while. We recommend being really honest with yourself here.
_____ Gross annual income
This is how much the earners in your household make on an annual basis, before taxes. This is not your “take home” pay, and you may need to get out a paystub to confirm the amount. If you're a salaried employee, this one is easier to find.
_____ Monthly debt payments
Add it all up. This includes your credit cards, car payment, student loans, you get the idea. You're paying more than the minimum on any credit card debt, right? (We’ll show you the math on that another time.)
_____ Down payment (minus $2,000)
This is the amount of cash you’ve saved to put down on a house. And if it’s not as much as you’d like, don’t worry. A 20 percent down payment is great, because you won’t have to add mortgage insurance to your monthly expenses. But it is definitely not the norm. There are loan programs that require as little as 3 percent down, and there’s a lot of down payment assistance out there.
It’s also important to realize that part of your savings will go to closing costs — the fees and expenses involved in buying a home. Closing costs vary from state to state, even city to city, but you can usually expect to pay at least $2,000. Some loan programs offer closing cost assistance, but let’s not count on that right now.
Whew, this step was the hardest. You’ll coast through the rest.
2. What’s your credit score?
You can get your estimated credit score for free at Credit.com or Credit Karma. It takes just a couple of minutes to sign up. But notice we said “estimated.” That’s because free scores aren’t your official “FICO score” that most banks use — that number can be a little different. This free estimation will work for our purposes though.
_____ Your credit score
This number can have a big impact on the interest rate banks will offer you, and in turn on how much house you can afford. Here’s the short story on what your credit score means for you:
750+ You should qualify for a variety of mortgages, with the best interest rates and the lowest fees.
680+ You’re likely to qualify, and with a good interest rate and standard fees.
600 – 680 You might qualify, but you’ll probably have fewer loan options and pay a higher interest rate and fees.
350 – 599 You probably won't qualify for a mortgage, except in some special cases.
If your score is below 600, don’t despair. This is not a permanent condition! Here are some ways to raise it.
3. What interest rate will you get?
Consult the chart at MyFICO. We like this chart because it adjusts the current mortgage interest rate by your credit score and state — just choose your state from the “location” dropdown menu, and note the interest rate (APR) that’s alongside your credit score. Ignore the “loan amount” field. Besides the fact that you don’t know it yet, all we want at the moment is the rate that banks might offer you.
_____ Your interest rate
Notice that this too is only an estimate. Banks will use a variety of criteria to determine your actual interest rate. But again, this one works for now.
4. What will your annual property taxes be?
Find your state’s effective real-estate tax rate at WalletHub. Tax rates can vary a great deal from city to city, but again, we’re going for ballpark. To be precise, try Googling the property tax rate for your city (careful not to accidentally grab a sales tax rate).
_____ Your property tax rate
While you’re at the WalletHub page, check out the actual dollars based on your state’s median home values. A lot of first-time homebuyers don’t realize just how much homeowners pay in local property taxes — nationally, an average of more than $2,000 each year.
5. Time to calculate
Here we go! Head on over to the calculator at Society of Grownups. Plug in all your numbers plus the additional fields. Most people go for a standard 30-year loan term. Homeowners insurance might run between $400 and $1,000; a typical annual bill of $800 is already filled in for you. Feel free to move ahead with that.
Planning to buy a condo? Monthly condo fees are often $200 to $400, but they can be much higher in posh communities. Guesstimate based on your plans, and then go back change the annual homeowners insurance figure to zero (condo fees normally include it).
You have a price tag!
The big number at the top is a ballpark maximum price tag for your new home. But keep going …
Below that, the monthly payment breakdown gives you a visual of what’s referred to as PITI (principal, interest, taxes, and insurance). You’ll notice a “PMI payment” that you didn’t plug in. That’s private mortgage insurance, required for conventional loans when the down payment is less than 20 percent.
Finally, just below the graphic, there’s the total monthly payment. How does that number feel? Next to that, there’s your debt-to-income ratio. Banks have strong feelings about that. Which brings us to step 6.
6. But wait … What’s your debt-to-income ratio?
Is your “debt-to-income ratio” under 36 percent? If it’s more than that, you probably won’t be able to qualify for a mortgage. You’ll need to pay down some debt, or increase your income, or some of both.
This rule isn’t carved in stone, but most lenders want to cap your total monthly debt payments, including your total mortgage payment, at no more than 36 percent of your gross income. Student loans can make this difficult for some of us. In certain cases, lenders will allow a debt-to-income ratio of as much as 43 percent.
So, can you afford to buy a home?
Is the price you can afford enough to buy a home in your area? Is your debt-to-income ratio in good shape? Well then, you’re on your way!
Just remember that the “affordable” home price is probably on the high side. A quick estimate like this doesn’t factor in all the costs of homeownership. As a homeowner, you’ll be paying for things you never had to think about as a renter. For example, most renters don’t pay their own water or sewer bill. The biggest thing, though, is repairs and maintenance. Each year, you’ll need to set aside at least 1 percent of your home’s purchase price. Probably more for an older home.
This is one reason why, in step one, we emphasized budgeting. To protect your investment, you’ll need to get good at it. It’s also about enjoying your home stress-free, knowing that you’ve got your financial bases covered if the water heater quits on you.
Ready for next steps?
Take the Framework online homebuyer course. Because you don’t know what you don’t know, and when you educate yourself, you’ll make decisions with confidence every step of the way. Most people finish the whole course in just 4 to 6 hours. Plus, when you pass, you get a certificate that can qualify you for programs that help first-time buyers afford a home.
Find a great real estate agent. Strangely enough, it’s kind of like online dating. Check out our 10 tips.
Start a relationship with a homeownership advisor. Before, during, and after your purchase of a home, our nonprofit advising partners are standing by to help with unbiased, expert advice specific to your situation. And it’s usually free.
Can’t afford a home just yet?
Remember, almost every homeowner was in that place at some point. Your next step is to make a plan for shifting the balance in your favor.
- Spend some time on your budget and make a plan to save
- Work on bringing up your credit score
- Consult a homeownership advisor
- Check out our beginner’s guide to down payment assistance
- If student loan debt is bumming you out, read this success story for inspiration
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Ready to take the next step in your homebuying journey with all the confidence of a smart and savvy homebuyer? Our comprehensive online homebuyer course is simple and easy to access on your computer, tablet, and mobile device. It's all the information you need, all in one place. Go ahead and get started today.
Filed Under: For Homebuyers