Buying a house can be a daunting task. You have to think about how much you can afford, the mortgage rate, and whether or not you’re comfortable with taking on a mortgage for 30 years. But what about the down payment? How much do you need to save up for that? And once you’ve saved up enough, is there a limit to how much house you can afford?
Enter the 28/36 rule. This nifty little guideline will help you figure out exactly how much house you can afford based on your monthly income and expenses.
Keep reading to learn more!
How Much House Can I Afford?
Purchasing a home is likely one of the largest decisions you will make. The mortgage rate, down payment, and mortgage loan term all need careful consideration. But once you’ve saved up enough for a down payment and opted for the mortgage term that’s right for you, how much house can you afford? Enter: The 28/36 Rule.
What Is the 28/36 Rule?
The 28/36 Rule – also called your front-end & back-end ratio – is a mortgage affordability guideline created by mortgage lenders as a means to determine how much house you can afford before applying for a mortgage loan. It’s designed to ensure that mortgage applicants can maintain monthly mortgage payments and monthly debt payments without over-extending themselves financially.
The rule says:
Your total housing expenses (mortgage principal and interest, property taxes, insurance, mortgage insurance if applicable) should not exceed 28% of your gross monthly income before taxes. Your total debt payments (including mortgage payments) should not exceed 36% of your gross monthly income before taxes.
How Do You Calculate Your Home Affordability?
So for example, if you earn $60,000 annually ($5,000 per month before taxes), your total monthly mortgage payment should not exceed $1,400 per month according to the 28-side of the rule. Simply multiply $5,000 by 28%.
Also, in the example above, your total debt payments should not exceed $1,800 per month according to the 36-side of the rule. This would include the $1,400 mortgage plus any car payments, student loans, minimum required payments on credit cards, and any other monthly debt payments. Here $1,800 is $5,000 multiplied by 36%.
Another method for calculating the 28/36 rule is to divide your desired monthly payment by 28% to figure out the gross monthly income you’d need to earn to afford a home with that payment.
For example, if you felt $2,000 was your desired monthly payment, you could divide this number by 28% and find that you would need a monthly gross income of $7,142 (before taxes).
Next, take the required income of $7,142 and multiply that by 36% to calculate how much other debt you could have (in addition to your mortgage payment) and still qualify for the mortgage loan.
This calculation comes out to $2,571 ($7,142 x 36%). That means if you subtracted the $2,000 mortgage payment, you could have an additional $571 in monthly debt.
Once you know how much payment you can afford, you can roughly calculate the overall home price you should be looking at. The fastest and easiest way of doing this is by using a home affordability calculator, like the one below. However, keep in mind this is based on having a good credit score, property taxes being around 1% in your state, and putting down 20%.
Assuming a 20% down payment, 3.5% interest rate, 30-year loan term, 1% for taxes, and .5% for insurance, a $300,000 home would equate to a $1,400 mortgage payment.
But if you’re still wondering “how much house can I afford” based on different factors, or want to know exactly what goes into this home affordability calculator, keep reading!
Four Factors That Affect Home Affordability
There are four main factors that affect how much home you can afford to purchase. By changing any of these factors you increase (or decrease) the mortgage payment, which ultimately affects the home price you’ll be able to purchase.
Out of the following four factors affecting the affordability of your home, your credit score is actually the least impactful. Although, it does still matter.
Typically, a credit score of 500 or above is required to obtain a mortgage loan (620 for conventional loans).
So long as you meet the minimum credit score required, the interest rate that you receive from the mortgage lender doesn’t change drastically. In fact, many times you can receive the same interest rate with a 680 credit score as someone with a 740 credit score but just may have to pay a bit more upfront in closing costs.
But overall, the difference between a 500 credit score and an 850 credit score will change the overall interest rate by around 1/2 – 1 percent.
And while you may be thinking 1 percent on your interest rate is a lot, and you’d be correct, typically when you have a lower credit score, you’ll be looking at other loan options like FHA or VA which don’t penalize you for a lower credit score.
Therefore, while a lower credit score does impact your ability to purchase a more expensive home, there are more options to minimize the effect.
Now we just talked about the interest rate above when explaining the impact of your credit score. However, more importantly, are how external factors affect interest rates.
Interest rates are constantly changing. Governmental factors, inflation, and the overall financial markets impact interest rates and can swing the rate you receive much more than your credit score.
In fact, just in one year, between February 2021 and 2022, the interest rates have risen an entire point (from 2.75% to 3.75%)!
To put this into perspective, at a 3% interest rate a $1,500 monthly mortgage payment equates to a home purchase price of $310,500. However, at a 4% interest rate, to stay at a $1,500 mortgage payment, you’d need to decrease your purchase price to $284,250. This effectively shaves off $25,000 of purchasing power just when the interest rates rise by 1%.
Another major factor that impacts the overall purchase price you’ll qualify for is your debt-to-income ratio.
Your debt-to-income ratio (DTI) is the percentage of your income that goes towards debt payment. Simply put, the more debt you have (prior to obtaining a mortgage) will directly impact how much home you’ll be able to afford.
Remember the 28/36 rule above? The 36-side of the rule takes into account all of your debt including car loans, student loans, minimum payments on credit cards, and any other required monthly payments you owe.
Therefore, even if you could qualify for a home, based on the 28-side of the rule, if you have a lot of additional monthly debt payments, you’ll likely not qualify or qualify for less home than if you had no or minimal monthly debt.
For example, if you earned $10,000 per month, the 28-side of the rule says your monthly payment could be $2,800 per month (roughly a $600,000 home with 20% down).
However, if you had $1,000 in monthly debt (outside of the mortgage loan you’d be applying for) the 36-side of the rule would say that your total debts would not be able to exceed $3,600 per month. This means you’d subtract the $1,000 from the $3,600 which equals a monthly payment of $2,600 (roughly a $560,000 home with 20% down).
As you can see the debt you carry can greatly impact the overall home’s purchase price you can afford.
The final factor that will affect how much house you can afford is your down payment. Down payments can vary from 0% down (with a VA loan) to as much as you want to put down.
The most standard down payments are 0% down (for VA and USDA loans), 3.5% down (for FHA loans), and 3-20% down (for conventional loans).
Typically, the more money you put down on a home, the more home you can purchase.
For example, if you could only afford to put 5% down on a home instead of 20%, your mortgage payment will be higher because you are borrowing more money over time. Due to this added interest, you’ll likely have to purchase a less expensive home in order for it not to impact your monthly mortgage expense (which is part of the 28/36 rule).
With 20% down, a $300,000 home would equate to roughly a $1,500 mortgage payment (assuming a 4% interest rate, 1% property taxes, and $100/month for insurance).
However, with a 5% down payment, to stay at a $1,500 mortgage payment you’d need to purchase a home with a price of roughly $235,000.
Private Mortgage Insurance
In addition to lowering your overall loan amount, when you put 20% down you remove private mortgage insurance which also helps to increase how much home you can afford. In fact, as you increase your down payment, the amount of mortgage insurance required decreases. Therefore, even if you can’t put down the full 20%, putting down 10% or 15% can reduce private mortgage insurance substantially.
House Affordability Options
Now that you understand how certain factors affect how much house you can afford, let’s talk about things you can do to increase your purchasing power.
Reduce Debt-To-Income (DTI)
The biggest impact you can make to afford a more expensive home is to lower your monthly debt obligations. If you have high monthly car payments, student loans, or credit card balances, paying these down prior to obtaining a mortgage loan can positively affect the price of the home you can afford.
For example, if you have $1,000 in monthly debt payments and earn $5,000 per month, you can increase your homes purchase price from $155,000 to $260,000 by simply reducing your monthly debt obligations by $500.
This might mean selling a car or paying off the auto loan or paying down your student loans or credit card balance. But as you can see this can greatly impact your ability to afford a more expensive house.’
Increase Down Payment
Sometimes saving for a greater down payment may be the best option to afford the home you desire. By increasing your down payment, you will lower the amount of your mortgage (what you borrow) which in turn lowers your monthly payment.
This lower monthly payment may be what you need to qualify for the home you want based on your debt-to-income ratio.
For example, if the highest payment you qualify for is $1,500, increasing your down payment from 5% to 10% means going from a $240,000 home to $255,000 (Increasing your down payment to 20% means you could qualify for a $300,000 home).
Increase Credit Score
As I mentioned earlier credit score does impact how much house you can afford but its effect can be minimized by either improving your score or finding a loan program that doesn’t penalize a lower credit score as much as a conventional loan does.
But for comparison’s sake let’s stick with a conventional loan. All things considered, let’s say the difference between the minimum conventional score of 620 and a 740 score results in a .75% difference in rate.
This means that a home with a price of $235,000 ($1,500 @ 3.75% w/ 5% down) would have the same monthly payment as a home with a $220,000 ($1,500 @ 4.5% w/ 5% down).
As you can see, improving your credit score may improve your ability to afford a more expensive home. However, the impact is not as great as some of the other factors discussed above.
Consider Different Loan Types
Choosing a loan type can also affect how much house you can afford. You’ll want to choose a loan program that matches your particular needs. There are loan programs that are more suited to buyers that have a lower down payment, higher debt-to-income ratio, lower credit score, or even the way in which you earn your income (W2 versus self-employed).
Below are some of the different loan programs you may want to consider outside of the typical conventional loan.
- FHA Loan – An FHA loan is an option for first-time buyers and buyers with lower credit scores. Buyers can qualify for an FHA loan with as little as a 500 credit score (with 10% down) and 580 (with 3.5% down). Also, 100% of your down payment on an FHA loan can be a gift. Finally, there are many down payment assistance programs that can be used with an FHA loan.
- USDA Loan – A USDA loan is another loan type designed for rural areas where conventional mortgages are more difficult to obtain. The main benefit of a USDA loan is that you can put 0% down. However, the property must be located in a specific USDA-qualified rural area.
- VA Loan – A VA loan is another loan type designed for military veterans or active service members that qualify. There are no down payment requirements on VA loans, though there is a funding fee of 2% that is tacked onto the loan amount. Finally, if you’re buying in certain areas you may be able to use state benefits like a first-time homebuyer credit.
Wondering how much house you can afford? You’ve come to the right place. We know that buying a home is one of the biggest investments most people will ever make and we want you to feel confident in your decision with all the information necessary.
Whether you’re an expert at calculating your own home affordability or not, our blog has plenty of resources for everyone! Are there any other questions about this topic that are burning up inside your brain?
If so, please let us know because it’s likely that another reader might be wondering too! We’d love to help answer their question as well.
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