How much can I afford when buying a house?

Interest rates on 30-year fixed-rate mortgages dropped over half a percentage point from their May 2024 peak, according to the U.S. Department of Housing and Urban Development’s Housing Market Indicators Monthly Update for August 2024.

With mortgage rates projected to fall further after Federal Reserve interest rate cuts in September, many homeowners may consider purchasing a home in the near future. For first-time homeowners especially, one major challenge is understanding the expenses associated with a home purchase and deciding whether they can afford it.

How to determine your homebuying budget

Determining your homebuying budget is more than just an estimate of what range you can afford or what down payment will be sufficient. The Consumer Financial Protection Bureau recommends identifying three aspects of your overall budget: 

1. Total monthly home payment, including repairs and utilities costs 
2. Down payment amount
3. Home’s cost over the entire loan term

What is the debt-to-income ratio and why does it matter?

Your debt-to-income ratio (DTI) is a measurement of how much of your income is used to pay debts. This measurement is referenced as a percent: If you have a 25% DTI, it means that a quarter of your income is designated for your existing debt. 

This debt includes payments like existing mortgage loans, auto loans, credit card payments, and student loans, not monthly expenses like car insurance or utility bills. Lenders use your DTI to determine whether you’ll be able to manage repayments on your mortgage. 

You can calculate your DTI by adding up all of your monthly debt payments and dividing it by your gross monthly income. Many websites have DTI calculators that you can use for free. 

How does your credit score affect home affordability?

Lenders will use your credit score to determine your interest rate. Most lenders use FICO credit scores to assess how you’ve handled debt in the past and how likely you are to pay off a mortgage loan. Mortgage lenders will check your report from monitoring agencies TransUnion, Experian, and Equifax when they determine which rate you qualify for. 

Here’s how to review your credit before you apply for a mortgage:

1. Request a credit report: You can request a free credit report from each of the credit agencies or you can visit AnnualCreditReport.com to get a copy. 
2. Review the information: Make sure there are no errors, outdated information, or closed accounts still listed.
3. Report mistakes: If you find any fraudulent or incorrect information on your credit report, dispute it with the credit bureau. You can use the agency’s website to file a dispute.

Your credit score and credit history impact not only your ability to secure a mortgage, but also your overall homeownership expenses. Typically, borrowers with higher credit scores have a better chance of securing a lower interest rate while borrowers with average to low credit scores will likely receive a higher interest rate. FICO considers a score of 670 to 739 to be a good credit score, while a poor credit score is below 580. 

What are the upfront costs when buying a house?

A down payment is usually the largest single upfront cost, which could range from 3% to 20%. If you were buying a $350,000 house, that would mean a down payment between $10,500 and $70,000. You’ll also need to budget for closing costs, which could range between 2% and 5% of the home’s purchase price; $7,000 to $17,500 for a $350,000 home. 

Other upfront costs you’ll need to budget for when buying a house include:

• Moving costs
• Furnishings
• Renovations

How do mortgage rates impact how much you can afford?

Mortgage interest rates influence your overall homeownership expenses and how much home you can afford, even if you have a sizable down payment. While the Consumer Financial Protection Bureau notes that your credit score and home location do impact your rates, the loan type, amount, and interest rate type are also significant. 

Even small changes in your interest rate can influence your monthly payment. Here’s how different interest rates alter the monthly payment for a $350,000 mortgage:

Loan term

The length of your loan can affect your interest rate and how much you can afford. Shorter loan terms often have lower interest rates and lower overall costs. For example, if you took out a $350,000 mortgage with a fixed interest rate of 6.5% and a 15-year term, you’d pay $198,797.64 in total interest. For the same loan and interest rate with a 30-year term, you’d pay $446,405.71 in interest alone. 

Overall expense and affordability, however, aren’t the same. Shorter loans tend to have higher monthly payments, which may not be as affordable as a more “expensive” overall loan with smaller monthly payments. In the previous example, while you’d save on interest over the life of the loan with a 15-year term, your monthly payment would be $3,048.88 compared to $2,212.24 for a 30-year loan. 

Loan type

You may qualify for one or more types of government-backed mortgage loans, such as a Federal Housing Administration (FHA) loan or Veterans Affairs (VA) loan. These loans often have lower interest rates and more lenient credit requirements than a conventional loan. However, in some cases the mortgage type could affect how much you can borrow. For example, conventional loans that conform to Fannie Mae and Freddie Mac standards have a borrowing limit of $766,550 in most areas. FHA loans, on the other hand, have a limit of $498,527.

Type of interest rate

Your loan’s interest rate will be fixed or variable. Fixed-rate loans give you a rate at the time of approval, and your interest rate will stay the same for the life of the loan. Adjustable-rate loans begin at one rate, but the interest rate may change at intervals until the loan is paid off. 

How much can I afford when buying a house FAQ

How can I use a home affordability calculator?

A home affordability calculator helps you estimate how much you’ll need to secure and repay a home loan. Many credit unions, banks, real estate websites, and government agencies offer a free home affordability calculator to help you estimate costs. Freddie Mac, for instance, has several tools that allow you to calculate everything from your down payment and closing costs to your housing expense ratio and choosing a 15-year vs. 30-year mortgage. 

What percentage of my income should go toward my mortgage?

The FDIC notes that lenders typically require your housing expenses to be no more than 25% to 28% of your monthly gross income. These expenses include your homeowners insurance, taxes, interest, and principle. In this scenario, if you make $10,000 each month, your monthly housing expenses should be no more than $2,500 to $2,800. This is referred to as a front-end ratio.

Lenders also consider your overall debt when determining whether to approve your loan application. The FDIC estimates that most lenders want to see a back-end ratio of 33% to 36%, meaning all of your combined debt should be lower than this range. If your income is $10,000 a month, your total debt payments shouldn’t exceed $3,600. If you have little to no other long-term debt payments, a lender may approve a mortgage with a monthly payment above 28% of your monthly income. 

Are there any hidden costs when buying a house?

Many buyers focus on saving for a down payment, as it’s such a large sum, but that doesn’t mean it’s the only savings goal you need to set when you purchase a home. Some homebuyers don’t anticipate “hidden” costs like moving, closing costs such as inspections and appraisals, repairs or renovations the home requires, and utilities. 

How much should I save for a down payment?

Many prospective homebuyers aim for a 20% down payment to purchase a house. You might be able to get a lower interest rate if your lender sees you have more at stake in the home, and you’ll need to borrow less if you can afford a larger down payment. 

You can purchase a home with a down payment below 20%, but it will cost you extra in some circumstances. Many lenders require the borrower to pay for mortgage insurance if their down payment is below 20%, which increases overall costs. Low- or no-down-payment loans or down payment assistance programs can help reduce your down payment amount.

Freddie Mac’s Home Possible and Fannie Mae’s HomeReady programs only require a 3% down payment. Local and national organizations like the Federal Housing Administration also offer assistance programs for qualified borrowers.