Buying a home is one of the most significant financial decisions you will ever make. While it’s easy to get swept up in beautiful photos on Zillow or HGTV tours, the most important step happens before you ever step foot in an open house: calculating your true budget.
The bank might tell you one number, but your lifestyle might tell you another. Here is how to determine exactly what house you can afford without becoming “house poor.”
1. Follow the 28/36 Rule
Standard mortgage lending follows a classic guideline known as the 28/36 rule:
- The 28% Rule: Your total monthly housing payment (including principal, interest, taxes, and insurance) should not exceed 28% of your gross monthly income (your income before taxes).
- The 36% Rule: Your total debt payments (including the new mortgage, car loans, student loans, and credit card debt) should not exceed 36% of your gross monthly income.
Example: If you earn $100,000 a year, your monthly gross income is $8,333. Based on the 28% rule, your maximum mortgage payment should be roughly $2,333.
2. Understand Your Debt-to-Income (DTI) Ratio
Lenders look closely at your DTI. While some programs (like FHA loans) allow for a DTI as high as 43% or even 50% in special cases, a lower DTI usually secures a better interest rate. To find yours, divide your total monthly debt by your gross monthly income. If that number is above 36%, you may want to pay down debt before applying for a mortgage to increase your buying power.
3. Factor in the “Hidden” Costs
The mortgage payment is only one part of the equation. When calculating affordability, you must account for:
- Property Taxes: These vary wildly by state and county.
- Homeowners Insurance: Required by lenders to protect the asset.
- PMI (Private Mortgage Insurance): If you put down less than 20%, you will likely have to pay an extra monthly fee.
- HOA Fees: If you are buying a condo or a home in a planned community, these monthly dues can add hundreds to your costs.
4. The Upfront Costs: Down Payment and Closing Costs
Knowing what you can afford monthly is different from knowing what you can afford upfront.
- The Down Payment: While 20% is the gold standard to avoid PMI, many first-time buyer programs allow for as little as 3% or 3.5% down.
- Closing Costs: Expect to pay an additional 2% to 5% of the home purchase price in closing costs (appraisals, inspections, title insurance, and loan origination fees).
5. Don’t Forget the Maintenance Fund
When you rent, the landlord fixes the leaky roof. When you own, it’s on you. A good rule of thumb is the 1% Rule: Set aside 1% of the home’s purchase price annually for maintenance and repairs. If you buy a $400,000 home, you should budget $4,000 a year ($333/month) for upkeep.
6. Get Pre-Approved (But Set Your Own Limit)
A mortgage pre-approval is a letter from a lender stating how much they are willing to lend you. It’s a crucial tool for making offers, but be careful.
Lenders often approve you for the maximum amount you can technically pay. They don’t know about your lifestyle choices—your travel budget, your child’s daycare costs, or your retirement goals. Just because a bank says you can afford a $600,000 home doesn’t mean you should take it.
The “Stress Test”
Before you sign the papers, try a “dry run.” If your estimated new mortgage is $1,000 more than your current rent, start putting that $1,000 into a savings account every month. If you can do that for 3–6 months while still living comfortably and saving for retirement, you know you can truly afford that house.
Final Thoughts
Knowing what you can afford isn’t just about a calculator; it’s about balance. By staying within the 28/36 guidelines and accounting for the hidden costs of homeownership, you can ensure that your new home is a source of joy and stability rather than a source of financial stress.