# How Much House Can You Afford?

## Point of Interest

Before shopping for a new home, determine exactly what you can afford and don’t forget about associated costs like down payments and interest payments.

First you had a dream home in mind, and then you found it on a real estate listing site. At this point, you’re practically organizing the garage, but can you afford the home? Most mortgage lenders recommend using the 28 percent rule, which means (in theory) that you shouldn’t spend more than 28% of your monthly income, before taxes, on your mortgage. In reality, the U.S. Bureau of Labor Statistics reports that the average American spends nearly 33% of their money on housing. Spending too much on housing causes many people to become house poor, unable to afford much else than their monthly basics.

Asking yourself “How much house can I afford?” now will help you avoid asking “Why did I think I could pay this mortgage?” later. Let’s break down how to determine how much house you can afford to take on.

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## Five tips to help determine how much you should spend on a house

### 1. Use the 28/36 rule

This rule is based on a calculation of your housing costs (including mortgage payments, insurance, property taxes, and condo or association feed) against your monthly income. The simple explanation is that your estimated monthly housing costs shouldn’t exceed 28% of your monthly gross income.

The more complicated explanation is that your debt-to-income ratio should also be evaluated when you’re asking “How much home can I afford?” Your debt-to-income ratio, or DTI, considers what percentage of your monthly gross income is used to make all debt payments (including house loan, credit card bills and student loans). Your DTI shouldn’t exceed 36%.

To recap: Your ideal housing payment is 28% or less of your gross income, and your total debt payments should be no more than 36% of your gross income. Hence, the 28/36 rule.

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.

\$50K annual income = \$1,166 monthly housing limit
\$60K annual income = \$1,400 monthly housing limit
\$75K annual income = \$1,750 monthly housing limit
\$100K annual income = \$2,333 monthly housing limit

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

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. Determine your down payment budget.

If you’re asking yourself “How much should I spend on a house down payment?” know that it’s a good question. The larger the down payment, the more home you can afford. For most buyers, the down payment comes from two sources — savings and the equity they’ve built up in their current residence. If you’re unfamiliar with equity, it’s 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.

Combine your cash down payment with the amount of money you’re prepared to borrow and you’ll have a maximum purchase price. However, don’t hesitate to revise this estimate as you shop for houses and mortgages. Figuring out how much to spend on a house changes as the variables change.

For instance, let’s say you get your heart set on a fixer-upper. You’ll 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.

### 5. Know your local housing market and plan accordingly.

The real estate market is in an unpredictable place. Home sales went largely on pause during the global COVID-19 pandemic, a struggling stock market caused many in-contract sales to fall through and changes in the short-term rental market might mean former rentals go on the market as homes for sale.

On the one hand, mortgage rates were trending down at the time this was written (as low as 3.31%). They might stay low, keeping monthly payments quite affordable. If that’s the case, you could afford to put in a larger offer than you’d expected. On the other hand, real estate in your area could come back with a vengeance and drive prices up.

If your maximum spend on a home is \$250,000, but desirable homes in your area have been selling for 5% above the asking price, it’s time to recalibrate. Anticipate going over by 5% and crunch some new numbers. With a maximum budget of \$250,000, that will translate to looking for homes with an asking price that’s \$12,500 — or 5% of your actual budget — lower than your max.

The bottom line is that the performance of recent sales in your market are the best indicator for how your own purchase will go. If other homes are selling for under the asking price, you should feel empowered to offer under asking on the home of your dreams.