How much house can you afford?

Hands holding a house and money fanned out.

Home prices are climbing. In some communities, last year's $200,000 house is selling for $220,000 today.

At the same time, mortgage rates have dipped slightly since last year, with the average 30-year rate still a historic bargain at a hair above 4%.

And it's gotten easier to get a mortgage. Banks have loosened requirements, accepting lower credit scores and as little as 5% down.

So this is the time to jump in and buy that house of your dreams, right? Right now, before prices go higher, before mortgage rates start climbing!

Not so fast.

There’s a reason they put those ticking clocks beside pieces of junk jewelry on shopping channels. Feeling you have to hurry leads to impulsive purchases — and a house, the largest purchase most of us will ever make, is no place to be impulsive.

Wise home-buying never changes: It's about figuring out what you can afford, how much you can put into a down payment and then sticking to your plan.

It doesn't have to be hard.

Follow these 5 smart moves, and you’ll be in great shape to buy a house that fits your budget.

Smart move 1. Spend 28% or less of gross income.

 

Maximum housing costs

We calculated how the 28% rule works out for various incomes. If you have one of the incomes below, here's the maximum you should spend.

Annual income Monthly housing limit
$50,000 $1,166
$60,000 $1,400
$75,000 $1,750
$100,000 $2,333

For many years, a rough benchmark has prevailed when it comes to figuring out how much home a prospective buyer can afford. It's called the "28/36 rule."

The first half works like this: Your monthly housing costs, which include mortgage, insurance, property taxes and condo or association fees, shouldn't exceed 28% of your monthly gross income.

Add together all of your income sources — salaries, business income, anything else — before taxes, then multiply by 0.28 and you’ll have a good idea of where your housing costs should land.

Some experts say spending less is even better.

Personal finance columnist Liz Weston recommends keeping your housing costs down to 25% or less of your income.

Smart move 2. Hold your overall debt payment to 36% of income.

 

This is the second half of the rule. Your monthly debt payments shouldn't exceed 36% of your gross income.

In other words, your mortgage, credit card bills, car and student loans, and other debts shouldn't break this barrier. To find out the amount, take your income and multiply by 0.36.

More debt equals less money available for a house payment. For example, if you have a monthly income of $5,000 and no other debts, you should be able to swing a home payment of $1,400 (5,000 x 0.28).

But if you have another $600 in other monthly loan bills, that amounts to 12% of your income. This means you’re only going to be able to spend 24% (36 minus 12) of that income on housing, which comes out to $1,200.

How debt limits what you can afford

Annual income Monthly debts Monthly housing limit
$50,000 $450 $1,050
$60,000 $575 $1,225
$75,000 $625 $1,625
$100,000 $900 $2,100

It's easy to put these rules to work. Just enter your income and non-mortgage debt payments into our mortgage calculator, and we'll tell you how big of a loan and monthly payment you can reasonably handle.

Here's a tip. If other debts are crimping your housing plans, focus on clearing off some of those credit card or student loan bills before you buy a home. You'll be way ahead in the long run.

Smart move 3. Determine how much you can put into a down payment.

 

The amount you can put down plays a big role in how much you can pay for your house.

Jim Merrill of Axel Mortgage Inc. in Phoenix says requirements have loosened significantly since the height of the recession, when lenders were demanding 20% down and excellent credit.

"Conventional loans are now available with as little as 5% down with a (credit) score as low as 620," Merill says. "For borrowers with great credit, the entire 5% down plus closing costs can come as a gift."

Another option is a government-backed FHA loan, which requires down payments of as little as 3.5%, or a VA loan, which can require no down payment at all.

But remember, the more you can put into a down payment, the more house you’re going to be able to buy or the lower your monthly payments will be.

Ideally, the money you use should be savings you've set aside for a home. If you don’t have the cash on hand, however, you might have another option.

Smart move 4. Choose wisely if you tap retirement accounts for a down payment.

 

If you don't have the up-front cash you need, an Individual Retirement Account (IRA) or 401(k) may be the only place you can turn for the money.

If that's the case, tap a Roth IRA or Roth 401(k) plan first.

Since contributions to Roth plans are fully taxed before they're made, you can withdraw what you've put into those accounts at any time without incurring penalties or additional taxes.

If you've held a Roth IRA for at least five years, you can withdraw an additional $10,000 in earnings without paying any penalties or taxes to buy or renovate a first home.

The next place to turn is a traditional IRA, which will allow you to withdraw up to $10,000 for the purchase of a first home without penalty. (If you have individual accounts, you and your spouse could take a total of $20,000.)

But since contributions to these accounts are tax-deductible, you'll have to pay income tax on withdrawals and a 10% penalty above the $10,000 limit until you reach age 59½.

Your employer's traditional 401(k) plan is the last place you should turn for a down payment. Such "hardship withdrawals" are fully taxed and incur a 10% penalty until age 59½.

The better option is taking out a loan against your 401(k). You can usually borrow up to $50,000 or half the value of the account, whichever is less. Your employer can give you up to 15 years to repay the loan if it’s for a home purchase.

Monthly payments are deducted from your paycheck. The interest you pay, generally a couple of percentage points above the prime rate, goes into your retirement account.

But now you're talking about a new loan payment that will reduce the amount you can borrow for a home.

You'll need to go back to Smart move 2 and recalculate.

What every renter needs to know before buying

If you've never owned a home before, you'll be shocked by the never-ending, often unexpected, costs and time sucks. Insurance can be a hassle. Utility bills are often stunning. And stuff breaks. Lots of stuff. Some of it can wait. Some of it has to be fixed right away to keep your house from falling down, burning up or even killing you. Here's how to cope with what's coming your way.

Smart move 5. Take into account the overall cost of moving into a new home.

 

Buying a house comes with a big after-purchase temptation. You want to make it as nice as possible. It's easy to go a little crazy on new furniture and decorations.

When you're applying for a mortgage, you’ll find your finances carefully scrutinized. But once you've bought a house, it's up to you to maintain discipline. It can be easy to run up your credit cards buying new stuff.

If you do so, you're putting yourself in the same hole you did all your original planning to avoid.

Even if you remain frugal, you’re going to end up buying a few things once you settle in. If you’re planning to do some remodeling, you’ll be spending even more. Try to take these costs into account from the beginning.

You'll also want to hang on to some cash for an emergency fund, and Weston recommends budgeting 1% to 3% of the cost of your home for annual repairs and maintenance.

Yes, this is hard when you’re buying a house. But you never know when disaster might strike, and that mortgage payment will be easier to make when it does if you've left yourself a cushion.