READ TIME: 4.5 minutes

Are you on the hunt for a new home and wondering how much you can really afford?

When determining how much home you can afford, lenders combine your monthly income and your monthly debt payments to calculate what monthly mortgage payment you can manage.

Next, lenders will then use that monthly mortgage payment to determine how big of a mortgage you qualify for based on the current interest rates, the loan term you choose and the amount you put down.

But this isn’t a one-size fits all approach and often lenders will approve you for a larger mortgage than you may be able to handle. That could turn the dream of being a homeowner into a financial nightmare.

So how much home can you really afford and how do you determine that amount?

Step #1: Create a Budget

Yes, the first step to determining how much home you can afford is to ask yourself, “Am I ready to actually buy a home?”

Home ownership is much more than just a down payment followed by a monthly mortgage payment. When you own the home, you’re on the hook for the taxes and the insurance that go with the home. You also own all the maintenance costs, the utility payments and all the other miscellaneous costs that come with being a homeowner.

Monthly Budget

Before deciding how much home you can afford, you first need to know how much you have to work with. This all starts with creating a simple monthly budget.

When looking at your monthly budget, first look at your monthly income. No, we don’t mean gross monthly income, but the amount that hits your bank account each month.

Once you know your monthly take-home pay, you can then determine how much mortgage you can afford.

Step #2: Use 25% of Your Income

As mentioned above, the lender will use your income and debt to determine your allowable monthly payment and then create the mortgage amount from there.

However, there is a very simple way to gauge how much home you can afford by using your income.

A good rule of thumb is to keep your total mortgage payment at 25% or below your take-home pay.

When we say total mortgage payment, we are referring to the total of the principal, interest, taxes and insurance payments.

Let’s say you determine your monthly take-home pay to be $6,000. Using the 25% rule, you know you can afford to make a total monthly mortgage payment of $1,500.

Next, using a mortgage calculator, you will find the home price you can afford is $268,000 on a 30-year loan at 3.5% interest. Keep in mind, this calculation includes a 10% down payment of $26,800, therefore creating a mortgage for $241,200

Using that same $6,000 take-home pay, here are some other options using a 30-year mortgage with a 3.5% interest rate:

  • $268,000 home with 10% down ($26,800)
  • $281,000 home with 15% down ($42,150)
  • $317,000 home with 20% down ($63,400)
  • $334,000 home with 25% down ($83,500)
  • $352,000 home with 30% down ($105,600)

Step #3: Emergency Fund

Buying a home is one of the largest financial decisions you will make in your lifetime. Therefore, it makes sense to start off with a solid financial foundation before you decide to buy.

Before purchasing a home, you will want to make sure you have a fully funded emergency fund in place. A fully funded emergency fund is between 3 to 6 months of emergency expenses, not income. Emergency expenses are those things you must pay for even during a financial crisis.

We are all familiar with Murphy’s Law: Whatever can go wrong will eventually go wrong.

Instead of waiting for disaster to strike as soon as you move into your new home, always start off with a fully funded emergency fund.

Step #4: Pay Off Your Debt

You don’t want to tack on a mortgage payment in addition to other monthly payments you’re already making. Before you start applying for a mortgage, try to pay down your credit cards, auto loan, student loans, and any other debt payments you have.

Yes, this may delay your ability to purchase a home, but remember buying a home may be one of the largest financial decisions you make in your lifetime. The best way to ensure your home is a financial blessing is to start your mortgage without any other debt.

Step #5: Save Your Down Payment

Unless you are opting for a VA loan or USDA loan, you will be required to make a down payment.

This can be anywhere from 3.5% to 20% or more depending on the type of mortgage you are getting. An FHA loan will require a minimum down payment of 3.5%, however you will also need to pay a monthly mortgage insurance premium, adding to your monthly payment and thus decreasing the amount of home you can afford.

On the other hand, you can increase the amount of home you can afford by putting 20% down and avoiding private mortgage insurance.

Still Have Questions?

Still have questions? Take a look at our mortgage calculator to help determine how much home you can afford. Also, feel free to pick up the phone and call one of our mortgage experts at OneAZ Credit Union.

Chris “Peach” Petrie is the founder of Money Peach. Money Peach partnered with OneAZ to provide free financial education to members across the state. To learn more about OneAZ’s partnership with Money Peach, click here.