Figuring out how much mortgage you can afford is the first step in buying a house.
Before you set your sights on that dream home, you will want to use either the 28/36 rule or a mortgage affordability calculator to determine the amount you can comfortably pay. Here's what you should consider when deciding what to spend.
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How Much House Can You Qualify for?
Lenders will tell you how much money they're willing to lend you after you apply for a mortgage. They assess several factors, such as your:
-- Gross income, or pay before taxes and other deductions
-- Down payment -- the larger it is, the more you will be able to borrow
-- Monthly expenses, such as auto or student loans and credit card payments
-- Credit score -- a higher score will generally get you lower interest rates and better terms
Lenders look at not only these factors but also costs associated with the home you want to buy, such as property taxes and homeowners insurance rates, to come up with an amount they are comfortable lending you. But what the bank agrees to let you borrow and what you should spend aren't necessarily the same thing.
How Much Should You Spend on a House?
A general guideline is to spend no more than 30% of your income on housing expenses. Lenders may use the 28/36 rule, which stipulates that housing expenses should not exceed 28% of your monthly gross income, and debt payments -- including your mortgage -- should not exceed 36% of your monthly gross income.
A home should fit your budget -- not the other way around. Just because a lender approves you for a mortgage doesn't mean you should use the full amount.
"'Afford' and 'qualify for' are two different things," says Casey Fleming, author of "The Loan Guide: How to Get the Best Possible Mortgage" and mortgage advisor for San Diego-based mortgage brokerage C2 Financial Corp. "Most people probably can't afford what they can qualify for. The key is whether or not you can really live on what you have left over after making your housing payment."
In addition to your mortgage principal and interest, you will need to consider other factors that can influence your homebuying budget, such as:
-- Property taxes
-- Homeowners insurance
-- Homeowners association, or HOA, fees
Overall, you may have to shoulder a lot of expenses that you didn't have when you were in a rental, especially if your home will be larger.
"Remember that after you buy a house, your housing-related expenses may go up," says Cathy Curtis, founder and president of Curtis Financial Planning, a financial advisory firm that specializes in serving women and their families. "You may pay more for utilities, you may need new furnishings, you might want to hire a gardener and you will most certainly have home maintenance expenses."
Buying too much house can leave you without adequate cash to cover the unexpected extra costs that come with owning a home. "I have seen many people that push the limits and buy the most expensive house they can qualify for and then struggle afterward to make ends meet," Curtis says.
[Read: Best Mortgage Refinance Lenders.]
Why Should You Use a Mortgage Affordability Calculator?
A mortgage affordability calculator can tell you how much house you can buy based on your income and expenses, including monthly debt payments.
Typically, you'll input your expected interest rate, loan amount and term, and down payment, plus HOA dues and annual insurance premiums and property taxes, to view an estimated monthly mortgage payment.
Using a mortgage affordability calculator is key because circumstances vary, even for borrowers who earn the same wages. If your annual salary is $100,000 but you spend $1,000 on monthly debt payments, for example, you can afford less house than someone with the same annual salary but only $100 in monthly debt payments.
Mortgage affordability calculators may also give you the maximum amount a lender could approve, even if you don't want to use the full amount.
[Read: Best FHA Loans.]
How Can You Avoid Being House Poor?
"House poor" describes homeowners who spend so much of their income on housing expenses that they can afford little else. Buying a home, especially your first one, can come with some sacrifices but should not sink your financial health.
If your house payment would prevent you from building an emergency fund, saving for retirement, or pursuing goals and hobbies, then you need to keep looking for a more affordable home.
When you're shopping for a mortgage, you can:
-- Become a knowledgeable buyer. Understand your market, including local taxes and insurance rates. Real estate listings may include estimates of these expenses, or you can research with your local property tax assessor and insurance agent. A real estate agent or mortgage professional should also be able to give you a good idea of these costs. You'll then know about how much you can comfortably commit to housing expenses each month.
-- Find the lowest-cost mortgage possible. Compare lenders to find the lowest interest rates and fees. Bonus: The less you pay to borrow money, the more you have to spend on your home.
-- Consider Federal Housing Administration or Department of Veterans Affairs loans, if you qualify. These programs could reduce your cost of borrowing to help you get into the home you want.
The question of how much house you can afford is not an easy one. Take time to analyze the factors that affect affordability -- income, debt, credit, savings and expenses -- to come up with an answer that will put you in a home you love without stretching your budget.
Roger Wohlner is a freelance financial writer and advisor based in Arlington Heights, Illinois. His work has been featured on Investopedia, Yahoo Finance, Go Banking Rates and other publications. Additionally, Roger writes extensively for various financial services firms, asset managers and other financial advisors. You can follow him on Twitter and LinkedIn. Roger contributes to his own popular finance blog, The Chicago Financial Planner, where he writes about issues concerning financial planning, investments and retirement plans.