couple going over a loan

How much can you afford to spend on a house?

Buying a home is one of the biggest purchases you’ll ever make. To a lot of first-time home buyers, the idea of buying a house can seem overwhelming. You might not know how much you can afford to spend on a mortgage payment each month, or worry you don’t have enough in savings to make a decent down payment on a house.

Feel free to set those worries aside for at least the next couple of minutes, though. By taking a closer look at your finances and exploring a few key factors, you can better understand the process and take another step towards securing the home of your dreams!

Calculating mortgage payments

You can put your calculator away, because we don’t have any numbers to crunch just yet. But how much you’ll pay each month depends on the home’s price, the down payment, the interest rate, homeowner’s insurance, property taxes, and the length of the loan.

According to financial advisors, the rule of thumb is not to spend more than 28% of your gross monthly income on housing expenses and no more than 36% on your total debt. Your total debt includes housing but also means any car payments, student loans and credit card payments you might have! This can help you establish a baseline for what you can afford.

The last thing you want to do is get your dream house and not be able to make the mortgage payments. Give yourself some breathing room, because with finances, it’s best to expect the unexpected! There will always be things that pop up that will impact your savings. Another good thing to strive for is having three months of living expenses saved at all times.

Consider your debt-to-income ratio

When reviewing your mortgage application, lenders will compare your monthly income to your monthly debt — otherwise known as your debt-to-income (DTI) ratio. The higher your DTI, the harder it’ll be to get a mortgage. Homebuyers with a higher DTI might also get a higher interest rate.

Try to calculate your own DTI beforehand and, if you can, pay off as much debt as possible to help your chances of qualifying before applying for a home loan.

Not everyone can afford a big down payment on a house

You might have heard that 20% of the purchase price is a normal down payment. And it’s true that lenders are usually more comfortable approving home loans with bigger down payments because that means they take on less risk. But not everyone, especially first-time home buyers, has the financial means to save up for a large down payment.

Fortunately, there are other ways to secure a mortgage without a large down payment. Federal Housing Agency (FHA) loans are made for low to moderate income borrowers and can be approved with a down payment as low as 3.5%. Veterans Affairs (VA) loans are to help eligible active duty and retired service members qualify for down payment-free mortgages.

The key is to explore your options. If the market is in your favor, there might also be an opportunity to refinance later at an even lower rate. 

Don’t forget about closing costs

Before you close the book on your budget, don’t forget to add closing costs. They are made up of fees for the services and expenses you need to finalize a mortgage, and usually run from 2% to 5% of the loan cost. Your lender might let you fold them into the loan, but in most cases you’ll be paying these one-time fees out-of-pocket to finish the process.

Your lender will outline the closing costs in the estimate you receive from your loan application.