How Much Home Can You Afford? Calculating Your Budget and Tips to Stay Within It

11.27.2024 | Category: Article

According to the Federal Reserve Bank of St. Louis, data shows the average sales price for homes sold in the U.S. was $501,100 last quarter, down from $521,900 a year prior. 

With home prices starting to dip in many key markets, many would-be homeowners are starting to ask, "How much can I afford?" And whether you're a first-time buyer or an experienced homeowner, getting a clear answer can still seem complicated. 

The good news is, with some simple calculations and a solid savings strategy, you can set a realistic budget that puts you on the path to homeownership.

Determine Your Price Range

To figure out what you can afford, start by calculating your monthly income and expenses. Lenders often follow the "28/36 rule" to help determine your budget. Using this guideline, your monthly mortgage payment (including taxes and insurance) should not exceed 28% of your gross monthly income. Additionally, your total debt payments (including the mortgage, car loans, student loans, etc.) should stay under 36% of your income. This rule can help you stay within a comfortable price range without overextending your finances.

For example, if your household gross monthly income is $10,000, ideally, your mortgage payment (including taxes and insurance) should be around $2,800 (28% of $10,000). To stay within the "28/36 rule," your total monthly debt payments—such as car loans, student loans, and credit cards—should not exceed $3,600 (36% of $10,000). 

This means that with a gross annual household income of $120,000, your mortgage payment should ideally be around $33,600 per year ($2,800 per month), and your total monthly debt payments should not exceed $3,600, leaving room for other financial obligations. This allows you to comfortably afford your mortgage while leaving room for other debts and living expenses.

Estimate Your Monthly Mortgage Payment

Once you know your budget range, it’s helpful to estimate what your monthly mortgage payment might be at various home prices. Use a mortgage calculator to adjust for factors like interest rates, loan term (15- or 30-year loan), and down payment amount. 

Once you've estimated your monthly mortgage payment, it's important to consider other factors that influence how much home you can afford. The Home Affordability Calculator can help you understand your potential loan approval amount by factoring in your income, existing debt, and monthly expenses. 

Additionally, using tools like the Loan Payment Calculator can help you fine-tune the specifics, such as the loan term and down payment amount, allowing you to explore different options to find the best fit for your budget. With these calculators, you can feel confident in your home-buying decisions, knowing your mortgage fits comfortably within your financial goals.

Account for Additional Costs

Mortgage payments are just part of the homeownership picture. Factor in property taxes, homeowners insurance, potential HOA fees, and maintenance costs. These expenses vary by location and property type, so make sure they fit within your budget. If you’re uncertain about these costs, a real estate agent or lender can provide area-specific estimates.

Set Savings Goals for Your Down Payment

A larger down payment can lower your monthly payments and may help you avoid private mortgage insurance (PMI), which is often required if your down payment is less than 20%. Start by setting a realistic savings goal. 

If your target is a 10% down payment on a $500,000 home, you'll need to save at least $50,000 for the down payment. Look at your budget to determine how much you can set aside each month and aim to automate savings transfers to keep you on track.

Plan for Closing Costs

Closing costs typically range from 2% to 5% of the loan amount. For a $500,000 loan, this could amount to $10,000 to $25,000. By planning ahead, you can incorporate these costs into your savings strategy, or you may have the opportunity to negotiate with the seller to cover a portion, depending on market conditions.

Finalize Your Budget and Start House Hunting

After crunching the numbers, you’ll have a clearer idea of what you can comfortably afford. Getting pre-approved for a mortgage before house hunting can also streamline the process and give you an edge in a competitive market. A pre-approval provides an accurate estimate of your borrowing limit and signals to sellers that you’re a serious buyer.

With these calculations and savings strategies, you’re ready to take confident steps toward finding a home that aligns with your financial goals.