When looking to buy a new home the most obvious question is: How much house can I afford to buy? If you are looking for a quick answer, you may be disappointed. There are many factors to consider. Fortunately, if you are able to familiarize yourself with the below mentioned aspects of buying a home, you will be able to come up with a useful answer as to whether your financial situation is right for home buying. 

 

Personal Income Calculations

 

Annual Income

It goes without saying that your annual income is an important indicator as to how much you will be able to spend on a house and therefore your mortgage payment. An important consideration to remember is to apply your net income to the calculation. Net income is the money you take home after taxes.

The 28% Rule

The rule of thumb is that you shouldn’t spend more than 28% of your gross income on your mortgage payment, this includes principal and interest. 

 

Example: with a household income of $100,000, following the 28% rule, you should not be spending more than $28,000 annually on your mortgage. This calculation comes out to around $2,300 a month. 

Monthly Expenses

Calculating how much you spend on average every month will give you a better understanding of your home buying capacity. Student loans, car payments, credit cards, average food and grocery expenses, and other necessary costs should all be taken into account. By considering these costs you may also be able to reevaluate exactly where your money is going and perhaps cut down on expenses to potentially increase your buying ability.

It’s also advisable that you allow for certain expenses which you should maintain for a healthy lifestyle and wellbeing, such as healthcare coverage and other insurances. You may also want to consider saving some funds set aside for any unforeseeable expenses, such as medical bills or car repairs. 

The 36% Rule

This 36% rule states that all household costs should not exceed 32% (stick with me…). This includes your mortgage meaning that, if you are following the previously mentioned 28% Rule, you are then left with 8% (the 36% less 28%) of your annual income to cover all other bills. Your credit cards, student loans, and car payments cumulatively should not exceed 8%.

Example: following the examples above, if your annual household income is $100,000 and $28,000 is going toward your mortgage, you are left with $8,000 for all remaining debt payments. That’s just over $650 a month. 

Debt-to-Income Ratio

This is a simple calculation. Take the total amount of debt you owe and divide it by your average monthly income. Here is an example: if your total debt is $2,000 and your average monthly income is $10,000 then your Debt-to-Income ratio (DTI) comes out to be 20%. The average lender wants your DTI to be under 36%. 

The 40% Rule

This rule states that your total amount of debt paid each month should not exceed 40% of your monthly income. Again, it’s important to include all debt, whether it’s student loans, a car payment, or credit cards. While student loans may not be as important to pay off right away, trying to pay off credit card debt before applying for a mortgage is advised. Lenders may deny home loans to those whose debt exceeds 40% of their monthly income. 

Down Payment 

The amount of money you pay upfront in order to get a home loan is called a down payment. This is usually a percentage of the house’s sale price. Typically, lenders require the down payment of 20% of the total value of the house, however the desired 20% is by no means absolutely necessary and many homebuyers are able to make a down payment of less than 20%. To buy a $600,000 house, a 20% down payment would be $120,000.

It is possible to get a mortgage and put less than 20% down, as there are many mortgage lenders which will allow a homebuyer to buy a home with a down payment as low as 3% for well qualified or well positioned buyers.

If you put down less than 20% as a down payment lenders will often require that you pay private mortgage insurance (PMI). The PMI usually sits around 0.5% of the remaining loan balance. Mortgage companies require you to carry PMI in order to protect themselves in case you default on the loan by missing payments.

Your home should be a personal sanctuary.

The 2.5x Rule

This calculation is easier to follow.  Prospective homeowners simply look for a house priced at around 2.5x their annual household income.

Example: A household with an annual income of $150,000 should consider buying a home priced at about $375,000. 

The 5x Rule

This rule applies to individuals who are completely debt-free. If you are in such a situation, you may consider buying a home at $500,000 while you have an annual income of $100,000.

Homeownership Costs

The cost of buying a house is not the only thing to consider. Once the house is yours there are still various costs which, if not taken into consideration, could be unforeseen expenses in the future. Barring major home disasters like flooding, pest infestations, etc., for which you might want to consider having a rainy-day fund, these costs may include:

• Maintenance and Repairs: According to a recent survey by Home Advisor, the average household in the U.S. spends about $4,000 annually on maintenance and repairs. 
• Utilities: Normally, utilities are more expensive for homeowners than for renters. The average homeowner spends around $300 more on gas, electricity, Wi-Fi, etc. than someone who rents. 
• Home Improvement: If the house you are looking to buy is not exactly what you are looking for, you may be considering doing some remodeling. If this is the case it is important to keep in mind that the average kitchen remodel can cost more than $20,000. 

What Can You Can Do Next?

Hopefully this article has given you some valuable tools in order to answer the question: “how much house can I afford?” By taking into consideration the many variables involved in purchasing a home and home ownership you will be better prepared to make the right decision.

While there is much that can be learned on your own, there is no substitution for a seasoned and local real estate professional. If you want to learn further and get specific advice and information about your situation, contact Los Angeles real estate agent Kat Delpit at Kat Delpit Real Estate. We’re based in Beverly Hills, California, and we have the knowledge and expertise to help you find your perfect home that fits all your needs while keeping you comfortable within your financial means.