How Much House Can You Afford?

The Five Key Factors in Mortgage Affordability

Before you start looking at homes, it's useful to know the factors that together determine what you can afford. According to the Consumer Financial Protection Bureau (CFPB), five key factors affect how much you can borrow and what monthly payment you can handle. Changing any one of these can change the affordable home price.

The five factors are: your gross monthly income, your monthly debt payments, your down payment, the interest rate on the loan, and the associated costs of homeownership such as property taxes, homeowner's insurance, and mortgage insurance if applicable. By understanding how each factor works, you can estimate a realistic price range for your home search.

• Gross monthly income: Your total income before taxes and other deductions.
• Monthly debt payments: Obligations like credit card minimums, car loans, student loans, and other recurring debts.
• Down payment: The amount you pay upfront, which reduces the loan amount.
• Interest rate: The cost of borrowing, which affects your monthly payment.
• Other homeownership costs: Property taxes, homeowners insurance, mortgage insurance (if your down payment is less than 20%), and potentially homeowners association (HOA) fees and maintenance costs.

Sources: Consumer Financial Protection Bureau (CFPB)

The 28/36 Rule Explained

A widely used guideline for mortgage affordability is the 28/36 rule. Many lenders and financial advisors use it as a starting point for how much you can borrow. The rule states that your monthly housing costs should not exceed 28% of your gross monthly income, and your total monthly debt payments—including housing—should not exceed 36% of your gross monthly income.

This leaves room for other debts and expenses.

It's important to note that the 28/36 rule is a guideline, not a law. Lenders may offer loans with higher ratios, and different loan programs have different limits. However, sticking to this rule is a conservative way to ensure you don't overextend your budget.

• Housing costs include principal, interest, property taxes, homeowners insurance, and mortgage insurance if applicable.
• The rule helps you avoid taking on a mortgage that might strain your monthly budget.
• Remember that the rule does not account for all your expenses, such as groceries, transportation, or childcare. You should factor those in separately.

Sources: Bankrate, Opendoor

How to Calculate Your Debt-to-Income Ratio

Your debt-to-income (DTI) ratio is a key measure that lenders use to assess your ability to manage monthly payments. It compares your total monthly debt payments to your gross monthly income. To calculate it, divide your total monthly debt payments by your gross monthly income and multiply by 100 to get a percentage.

Most lenders prefer a back-end DTI ratio (which includes all debts) of 36% or lower for conventional loans, though some may approve up to 43%. Other loan programs, such as FHA loans, may allow higher ratios in some cases, potentially up to 50%, if there are compensating factors. These limits can vary by lender and program, so it's wise to ask your lender for their specific guidelines.

• Front-end DTI: only housing-related expenses (like the 28% figure).
• Back-end DTI: all monthly debt payments (like the 36% figure).
• Use your gross income, not take-home pay, for this calculation.

Sources: Bankrate, Opendoor

Impact of Down Payment on Affordability

The size of your down payment directly affects how much you can afford. A larger down payment reduces the loan amount, which lowers your monthly payment and can increase the price of home you can afford. If you put at least 20% down, you typically avoid paying for private mortgage insurance (PMI), which adds to your monthly costs.

If you put down less than 20%, you will likely need mortgage insurance, which protects the lender if you default. This additional cost is part of your monthly payment, so it reduces the overall loan amount you can borrow.

Alternatively, you could put down a smaller percentage and pay PMI, which would increase your monthly payment and reduce your affordable home price.

• A larger down payment increases your buying power by reducing the principal.
• Avoiding mortgage insurance saves money monthly.

Sources: Consumer Financial Protection Bureau (CFPB), Bankrate, Opendoor

Using an Affordability Calculator Effectively

An affordability calculator can help you estimate a reasonable home price based on your income, debts, down payment, and other factors. To get the most accurate result, you should input realistic numbers for your monthly debts, property taxes, and insurance. The calculator will then show you a maximum home price and an estimated monthly payment.

Remember that a calculator is only a starting point. It uses assumptions that may not match your exact situation. It's important to consider your own spending habits, future expenses, and comfort level with your monthly payment. Also, the output is only as good as the numbers you input—if you underestimate your debts or taxes, the result will be too optimistic.

After getting a ballpark figure, you can refine it by working with a lender who can provide a preapproval based on your actual financial data. That preapproval will show you a specific loan amount you qualify for, which is more concrete than a calculator estimate.

• Include all your monthly debts, not just minimum payments.
• Use a realistic estimate for property taxes and insurance in your area.
• Treat the result as a guide, not a guarantee.
• Work with a lender for a precise preapproval.

Sources: Consumer Financial Protection Bureau (CFPB), Opendoor