Introduction

To calculate how much house you can afford, we have to factor in a few items, including household income, monthly debts and the amount you have for a down payment. As a home buyer, you’ll want to have a certain level of comfort in understanding your monthly mortgage payments. While your household income and regular monthly debts may be relatively stable, unexpected expenses and unplanned spending can impact your savings. A good rule of thumb is to have three months of payments, including your housing payment and other monthly debts, in reserve. This will allow you to cover your mortgage payment in case of some unexpected event. We call this an “Emergency Fund.”

Debt-to-income ratio (DTI)

The most important metric that a mortgage lender uses to calculate the amount of money you can borrow is called the DTI ratio. This ratio compares total monthly debt to your monthly pre-tax income.  Generally speaking, housing expenses shouldn’t exceed 30% of your monthly income. As an example, if your monthly mortgage payment, with taxes and insurance, is $1500 a month and you have a monthly income of $5000 before taxes, your DTI is 30%. 

Typically the lower the DTI ratio you have, the better your credit score is. This ratio is also the bedrock number that you, as a buyer, should use to calculate what you can and cannot afford. This method will keep you from overextending yourself when calculating your monthly payments. Always do this calculation despite what an overly eager real estate advisor might tell you.

How much house can I afford with an FHA loan?

To calculate how much house you can afford, given a 20% down payment, you might be best served with a conventional loan. However, if you are considering a smaller down payment or have a low-to-moderate income, you may qualify for an Federal Housing Administration (FHA) loan. FHA loans require a lower minimum down payment (down to 3.5%) and lower credit scores than many conventional loans.

These loans also can have more relaxed qualifying standards  -  something to consider if you have a lower credit score. It is important to note that FHA loans do have some restrictions, including restrictions on condominium purchases if there are too many rentals in the building. 

How much house can I afford with a VA loan?

A VA loan is a mortgage loan available through a program established by the United States Department of Veterans Affairs. These loans are backed by the federal government but issued through private issuers and are only available to active and veteran service personnel and their families. That’s a big deal, as VA loans typically don’t require a down payment. Make sure to talk to a qualified Mortgage Broker to understand whether you can qualify for that type of lending program. 

The Bottom Line

Choosing the amount that you will finance on a home is one of the most important financial decisions you can make. It is an extremely personal choice that should not be determined by a real estate broker. They might tell you how much you can afford, but that number may be vastly different than the number you are comfortable with. Your home should be a source of pride and comfort, not a reason to sit up at night.