How much house can I afford? The answer to that question depends on a lot of factors, including your income, your debts, your current expenses, and the down payment you plan to make. To determine how much house you can afford, you’ll want to consider two things:
The maximum amount that you can borrow from the bank. This is called the “loan-to-value ratio” or LVR. The LVR is a calculation you can get from your mortgage broker or financial institution, which will vary depending on how much equity you have in your home, your credit rating, and other factors. A higher LVR means you can borrow more for a house, but it also means that even a small decline in the value of your home could put you “underwater,” with more money owed to the bank than what the home is worth.
You can afford to spend the maximum amount on the house each month. This number changes as your needs change — if you have children, you will probably need more space than if all you had was a dog. It also changes as interest rates change and the prices of homes in the area go up or down.
Where will your mortgage payment fit in?
The first step to determining how much you can afford is figuring out where your mortgage payment will fit into your overall budget. This is a rough estimate of what’s leftover after your mortgage payment. To estimate this number, follow these steps to know more about property estimator:
- Subtract your monthly debt payments from your monthly take-home pay.
- Subtract any additional recurring monthly payments for car loans, student loans, or child care from that amount.
- Add up any recurring but irregular payments such as life insurance premiums, homeowners’ association dues, or quarterly property taxes to get the total amount of money you expect to spend each month.
The 28/36 rule
The 28/36 rule was proposed by Edmund E. Brown, Sr., then governor of California, in 1961. Many financial institutions have since adopted it as a starting point for estimating mortgage affordability for homebuyers. Although it is commonly referred to as a rule, it is more accurately described as a guideline or benchmark. Many financial institutions have stricter internal policies than this rule and may not be suitable for some borrowers.
In order to calculate your maximum monthly mortgage payment, use the following formula:
Monthly housing payment (principal and interest only) = 28% of gross monthly income
Monthly housing payment plus total monthly debt payments (principal and interest) = 36% of gross monthly income.
A good rule of thumb is to not spend more than 28% of your monthly income on housing costs (mortgage payment, insurance, property taxes, and any other homeowner expenses). If your total housing costs are greater than that, you should consider cutting back on other monthly expenses like food or entertainment until you’re able to make a larger down payment or qualify for a lower interest rate.
How much do you currently spend on housing? How much of your income goes toward housing? This can vary widely depending on where you live.
And as you look at homes in various neighborhoods, remember that location matters. Some areas are more expensive than others. A home near a good school might be more expensive but would be worth it if that’s a priority for your family. A home near a great park, shopping or restaurants could also be worth paying more.
You may have the ability to pay for a larger house now, but what about tomorrow? If you plan to stay in the same home for five years or more, take inflation into consideration. That way, you won’t find yourself struggling to make mortgage payments 10 years if salaries don’t keep up with living costs.