Choosing The Right House For Your Budget

Most mortgage lenders determine how much house you can afford by using the 28 percent rule. This “rule” says that you shouldn’t spend more than 28% of your monthly income, before taxes, on your mortgage. Individuals and households have other expenses to factor in this calculation. Debts and expenses like student loans, car payments, property tax, and PMI all factor into this balance.

It’s all about figuring out how much house you comfortably afford because you don’t want buyer’s remorse to be a feature of your new home.

Five Tips to Help Determine How Much You Should Spend On A House

1. Figure out how much you can afford to borrow.

For many years, home-buyers seeking a mortgage have been well-served by what’s called the 28/36 rule. It says your total:

  • Monthly housing costs, which include mortgage payments, insurance, property taxes and condo or association fees, shouldn’t exceed 28% of your monthly gross income.
  • Monthly debt payments, including credit card bills and student loans, shouldn’t exceed 36% of your gross income.

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 on a house.

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

It’s easy to put these guidelines to work.

Enter your monthly income, bills, and projected housing costs into our mortgage calculator to determine exactly how much home you can afford and the monthly mortgage payment you can reasonably handle.

How debt limits what you can afford

Annual incomeMonthly debtsMonthly housing limit
$50,000$450$1,050
$60,000$575$1,225
$75,000$625$1,625
$100,000$900$2,100

And remember, it’s the average cost of financing a home. Savvy borrowers with decent credit can almost always pay a quarter to a half of a point less.

Spend a few minutes searching our extensive database for the best current mortgage rates from dozens of lenders in your area to get a good idea of what you can expect to be charged.

An online real estate listing for the size and type of home you hope to buy can provide property tax and insurance costs you’ll need to get an estimate of how much house you can afford.

2. Add up how much you have for a down payment.

The bigger the down payment, the bigger the home you can afford to buy. For most buyers, the down payment comes from two sources — savings and the equity they’ve built up in their current residence. (Equity is the current market value of a home minus what you still owe on mortgages.)

Ideally, you’ll be able to make a down payment of at least 20% to avoid paying mortgage insurance. But borrowers can qualify for conventional mortgages with down payments of 3% and credit scores as low as 640, according to Jim Merrill, founder of Axel Mortgage Inc. in Phoenix.

And options are available for lender-paid or discounted mortgage insurance, including programs from Fannie Mae and Freddie Mac, the government-created lending institutions, that also will let you use a monetary gift for a down payment. A good mortgage broker can run you through the possibilities.

If you’re struggling to qualify for a conventional loan, 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.

3. Choose wisely if you tap retirement accounts for a down payment.

Taking money out of retirement plans for a down payment is not ideal. But we know that many families have most, if not all, of their savings tied up in individual retirement accounts (IRAs) or 401(k) accounts where they work.

If that’s the case, tap a Roth IRA or Roth 401(k) plan first. Because 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 to buy or renovate a first home without paying any penalties or taxes.

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 of 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.

4. Calculate an affordable home purchase price.

Add how much you have for a down payment to the maximum amount you should borrow, and that’s how much house you can afford. Don’t hesitate to revise this estimate as you shop for houses and mortgages.

Has a fixer-upper popped up on your wish list? If so, you probably need to reduce the size of your down payment to have more cash available for renovations. Do the homes you’re looking at have lower property tax bills, or higher association fees, than you expected? Have you found the perfect lender offering a lower interest rate?

Go back to the mortgage calculator, and revise your borrowing power.

Dodging these pitfalls will make you a happier homebuyer now and a more satisfied homeowner down the road. You’ll know that you got the best possible mortgage and won’t be overwhelmed by unexpected costs.

5. Know your local housing market and plan accordingly.

It’s a seller’s market across most of the country again, creating lots of pressure to commit more than 28% of your income to housing.

Let’s say you can buy a house for $250,000, but you determine that desirable homes in your area have started going for about 5% above the asking price. That means you need to adjust the price of the homes you’re looking for — at least the best ones — down by about $12,500 (5% of your actual budget).

If you absolutely must spend more than these calculations say you can afford on a house, figure out how much more you’re committing and go into the purchase with your eyes wide open. Should all of the extra money have to come from a bigger mortgage, you can probably cope with spending an additional 10% without too much pain or inconvenience.

But once you get up to 20% or 25% more, you’ll have to make significant changes in other parts of your life, such as suspending contributions to retirement plans and college funds, or giving up vacations or other big-ticket items. You’ll know what it means to be house-poor, and that’s what we’re trying to avoid.