Calculate How Much House You Can Afford

Whether you are looking to buy your first house or thinking of moving on to a new one, you'll need to know how much house you can afford. Not taking these calculations into consideration can leave you rejected from home loans or, if you get a loan on terms you can't afford, lead to foreclosure down the line. When determining your price range, you'll have to calculate both your ability to make monthly payments and how much you can pay as a down payment.

Steps

Determining How Much You Have for a Down Payment

  1. Consider your assets. A down payment requires you to pay a certain amount of money on the spot. This amount is usually determined by the purchase price of the house and the lender requirements (it may be anywhere between 0% and 25% of the selling price of the house). When you apply for a mortgage, the mortgage lender will want to know how much cash you have available for the down payment. Look at all your liquid assets, such as your savings and/or any monetary gifts from family members, to determine a likely maximum downpayment.[1]
    • Be aware that most private lenders will be looking for "seasoned" assets, meaning they've been in your account for two months or longer.[1] Quickly transferring money into your account right before you apply for a loan may still cause your loan application to be rejected, even if you have enough for the down payment. Lenders want to see that you are able to save and that you're not lying about your income.[1]
  2. Know how much you will need for a down payment. For a typical FHA or conventional mortgage, you will usually only be allowed to borrow about 80% of the appraised value. Your down payment will have to cover the difference between that and the selling price. This means that in order to buy a house, you'll need about 20% of the value of the home.[2]
    • Note that the appraised value may be higher or lower than the selling price of the house.[3]
    • Start thinking about how much you'll need for a down payment for the house you want and how much you can reasonably afford.
    • If you have $30,000 saved for a down payment, for example, you can use it as a down payment for a home that costs $150k.
  3. Understand the various financing programs that might be available. Different financing plans require different down payment amounts. You may get a conventional loan or be eligible for a government-backed loan, such as a VA or Federal Housing Administration (FHA) loan.
    • If you can't afford a 20 percent down payment on your home, but have good credit and steady income, a mortgage broker may assist you with a combination mortgage. In that, you're taking out a first mortgage up to 80% of the value of the home, and a second mortgage for the remaining amount. While the rate on the second mortgage will be slightly higher, the interest on it is tax-deductible and combined payments should still be lower than a first mortgage with PMI.[4]
    • Certain cities offer programs to support homebuyers. For example, Atlanta offers a program called Invest Atlanta that gives qualified homebuyers an interest-free second mortgage to cover the cost of a down payment.[5] Search online for housing assistance programs in your area.
    • If you're a military veteran, you may qualify for a zero-down payment mortgage through the U.S. Department of Veterans Affairs (VA). These mortgages do not require PMI and protect the buyer from paying too much in closing costs, making them a great deal for those who qualify.[6]
    • A FHA loan is insured by the government and may allow a private lender to reduce your down payment to between 3.5 and 10% of the purchase price.[7][8] Usually you need a minimum credit score of 580 to qualify for a FHA loan.[8]
    • Conventional loans are not insured by the federal government and usually require 10–25% of the purchase price for a down payment.
  4. Consider paying less than the standard amount. While most banks will be reluctant to loan to a buyer making a very low down payment, government programs may help you get a mortgage with a down payment as low as three percent. In addition to FHA loans, look into low down payment loans through the lenders Freddie Mac and Fannie Mae.[2] Putting down less usually requires more of the buyer and an additional form of insurance, but can be a reasonable way for new buyers to achieve their dreams of homeownership.
    • In order to get one of these loans, a buyer must:
      • Buy private mortgage insurance (PMI). This can cost $50 per month or more depending on the value of your home.[5]
      • Have a fair credit score (usually over 620)
      • Provide evidence of income, job status, and assets.
      • Undergo homeownership counseling[2]
    • Be aware that there are risks associated with these programs. While your down payment will be very low, you may end up paying a great deal more in the long-term due to potentially higher interest rates and paying into a PMI, which does not increase equity.[9]

Calculating Your Maximum Monthly Payment

  1. Know the ratios lenders are using to determine if you qualify for a loan. "28 and 36" is a commonly used ratio. It means that no more 28% of your monthly gross income (your income before you pay taxes) should go towards paying housing expenses (including mortgage payments, real estate taxes, and insurance). In addition, monthly payments on your outstanding debts, when combined with your housing expenses, must not exceed 36% of your monthly gross income.[10]
    • Find each percentage for your monthly gross income. For example, if you make $45,000 per year, you have $3,750 in monthly income. 28 and 36 percent of $3750 equal $1050 and $1350, respectively.
    • In this situation, this means that your monthly housing expenses should be no more than $1050, which represents 28% of your monthly income. In addition, your total payments on debt, including on your car and mortgage, should not exceed $1350, which is 36% of your monthly income. If your projected payments are higher than these values, the bank may decline your mortgage application.
    • So, if you maxed out your housing payment amount at 28% and paid $1050 per month, you would have $300 per month remaining to pay down your other debt ($1350 - $1000= $300).
    • Monthly payments on outstanding debts (included in the 36%) can include car payments, alimony, credit card payments, or any other debts you pay monthly (like student loans).[11]
  2. Calculate your expected housing expenses. You'll need to estimate the annual real estate taxes and insurance costs in your area and add those numbers to the average price of the home you want to buy. You should also add an estimate of how much you can expect to pay in Save on Closing Costs, which are charges and fees that generally run between 3 to 6 percent of the money you're borrowing.[12] Credit unions often offer lower closing costs to their members.
    • Put these totals into a mortgage calculator to find your monthly payments. You can find a calculator online or make your own in a spreadsheet. If the figure is above 28% of your gross income then you will have a hard time getting a mortgage.[13]
  3. Increase your ability to pay. If your target home or home price has a monthly payment that you are currently unable to pay, you have several options. You can either look for cheaper housing, wait several more years and work towards earnings more income, or increase your ability to pay more quickly. This third option can be done by reducing your debt or by increasing your available income.
    • Reducing debt simply means paying off any outstanding debt you currently have. This can include car payments and credit card debt. Once you have taken care of these debts, you are able to contribute more each month to your mortgage.
    • Increasing available income does not simply mean making more money, though it can be taking on a second job or finding part-time work. Instead, this can mean sending a non-working spouse to work or going in together on a house with a partner or friend.[14]
  4. Determine if you can afford the house you're looking for. After considering the above money-saving options, determine your ability to pay using your specific circumstances and an online mortgage calculator. Weigh the pros and cons of taking on an additional job, taking out a high-interest loan, taking out a loan that requires PMI, or saving for a large down payment before committing to any of these options.

Selling Your Current Home to Afford a Down Payment

  1. Understand the risks and benefits of selling and buying a house at the same time. If you are looking to "move up" — that is, sell your current home and buy a new house, you may need to wait for your current home to sell so you can afford the down payment on your new home and avoid paying two mortgages.[15] If you sell your house first, you may feel pressured to find and buy your new house quickly, but it may also give you the money you need to put a down payment your dream home.[15]
    • You may have to make an offer on your new house but negotiate for the purchase to be contingent on the sale of your old house. Contingent offers are more risky and less desirable for the seller, since the sale can't be completed until the buyer's house is sold. You may want to put your current house on the market first.
  2. Calculate the likely sale and profits from your existing home. The amount of money you will make selling your home depends on a variety of factors, including how much you still owe on the home, any fees you will need to pay a realtor, property taxes, etc.[16] If you son't know how much your house will sell for, investigate recent sales in your area of similar homes and use that as a starting point.
    • Let's say you think your house will sell for $250,000. Subtract the amount you still owe on your mortgage from this number. So if you still owe $75,000, $250,000 - $75,000 = $175,000. From that number, subtract any additional fees, such as your real estate agent's commission (this may be a percentage of the sale price or a flat fee), closing fees, transfer tax, and whatever property taxes you owe (you pay these up to the day you sell the house). Assume your realtor gets 6% of the sale price ($15,000), there's a total of $750 in closing fees, and you owe $500 in property taxes. Add these numbers together ($15,000 + $750 + $500 = $16,250) and subtract that from $175,000 to find how much you will make from selling your house. $175,000 - $16,250 = $158,750.
    • You will have $158,750 to put toward a down payment on a new house
    • Search online for "Home Sale Proceeds Calculator" to easily plug in these numbers and find your profit.

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Sources and Citations

  1. ↑ 1.0 1.1 1.2 http://www.thetruthaboutmortgage.com/assets-and-reserve-requirements/
  2. ↑ 2.0 2.1 2.2 http://www.magnifymoney.com/blog/pay-down-my-debt/3-down-payment-mortgage554237829
  3. ↑ http://www.thetruthaboutmortgage.com/appraisals-and-appraised-value/
  4. ↑ http://www.investopedia.com/terms/c/combination_loan.asp
  5. ↑ 5.0 5.1 http://www.forbes.com/sites/trulia/2014/04/02/dont-have-a-20-down-payment-for-a-home-check-out-these-alternatives/
  6. ↑ http://www.forbes.com/sites/trulia/2014/04/02/dont-have-a-20-down-payment-for-a-home-check-out-these-alternatives/2/
  7. ↑ http://portal.hud.gov/hudportal/HUD?src=/buying/loans
  8. ↑ 8.0 8.1 https://www.lendingtree.com/mortgage/fha-loan-eligibility-article
  9. ↑ http://www.magnifymoney.com/blog/pay-down-my-debt/3-down-payment-mortgage554237829/
  10. ↑ http://www.investopedia.com/terms/t/twenty-eight-thirty-six-rule.asp
  11. ↑ http://www.bankrate.com/calculators/mortgages/new-house-calculator.aspx
  12. ↑ http://www.investopedia.com/terms/c/closingcosts.asp
  13. ↑ http://guides.wsj.com/personal-finance/buying-a-home/how-much-you-should-spend-on-a-home/
  14. ↑ http://www.mtgprofessor.com/A%20-%20Purchasing%20a%20House/how_much_house_can_you_afford.htm
  15. ↑ 15.0 15.1 http://www.nolo.com/legal-encyclopedia/moving-up-selling-home-buying-29788.html
  16. ↑ https://www.regions.com/Insights/Personal/Mortgage-Calculators/how-much-will-i-make-selling-my-home
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