Determining How Much House You Can Afford

Determining How Much House You Can Afford

Are you struggling to determine how much house you can afford? You’re certainly not alone. Many homebuyers have a difficult time setting a home-buying budget simply because there are so many factors that go into making this decision. A $500,000 home, for example, could carry very different monthly mortgage payments depending on factors like the interest rate, down payment, and loan term (and don't worry; each of these will be discussed in turn).  

But knowing how to determine your house budget is a critical skill that can prevent you from overspending or taking on more debt than you can comfortably repay. It can also prevent you from being overly tight with your money; a budget allows you to spend without guilt to make sure you get the type of home you want. 

In this article, you’re going to learn how to figure out your house budget, including:

• Upfront investment amounts, 
• Ongoing homeownership expenses, and
• Factors that determine the overall cost of your home purchase.  

There is a lot to consider when determining how much house you can afford. If you’re looking for a quick, easy calculation, check out this Mortgage Affordability Calculator. And if you want to take a closer look at all of these home-buying budget factors, keep reading.

The Upfront Investment Of Buying A Home

Here are the upfront expenses most buyers encounter when investing in a home. 

The Down Payment

The down payment is the amount of the purchase price that you pay out-of-pocket. 

Traditionally, a down payment would be at least 20% of the purchase price.^[1] But today, you have more options. In fact, depending on your loan type and financial situation, you might qualify for a down payment of just 3-5%. 

Some buyers may even qualify for 0% down payment home loans. Active military members, veterans, and their spouses, for example, might consider a zero-down-payment VA loan. Buyers in rural communities might look into a specialized USDA loan. There may be additional loan types and down payment assistance programs available to help you. Reach out to a Mortgage Loan Officer to explore your options.  

Here are a few tips to keep in mind as you decide how much to spend on your down payment:^[2]

• A lower down payment costs less upfront, potentially making homeownership more accessible and leaving you with cash available to cover other expenses. 
• A higher down payment reduces your monthly mortgage payments and saves you money in the long term. 
• A lower down payment may require mortgage insurance. Mortgage insurance is a policy that allows lenders to offer low down payment loans by protecting them against default. 
• A higher down payment gives you more home equity. This equity can potentially be leveraged in the future if you need cash for renovating, covering a large, unexpected expense, or paying for higher education.     

Closing Costs

Closing costs are the fees associated with finalizing your home loan and home purchase.^[3] The U.S. Consumer Financial Protection Bureau reports that closing costs typically range from 2-5% of the purchase price. However, many factors contribute to closing costs, so your actual costs may fall outside this range. As you choose a home and get closer to your closing date, you’ll be provided with updated closing cost estimates.     

It’s worth noting that you might be able to get assistance with your closing costs. Some home loan lenders may offer programs that allow you to roll some of the closing costs into the home loan so you don’t need to pay as much out of pocket.

Depending on your local market conditions, you might even be able to negotiate to have the seller help cover some of the closing costs. In slow markets, sellers may be willing to pay some of your closing costs from their proceeds to incentivize you to choose their listing. Ask your real estate agent if this is a possibility in your area. 

Any Urgent Repairs or Renovations

You may have urgent repairs or a renovation project that you want to begin immediately after buying the home. If so, make sure you include this cost in your home-buying budget.  

Emergency Cash Reserves

As a homeowner, you will inevitably encounter unexpected expenses. The heating system may go out, a leak may need to be addressed, or an appliance may need to be repaired. It’s always a good idea to have some savings available to cover these unplanned maintenance issues. 

Ongoing Expenses For Homeowners

The ongoing costs of homeownership are just as important as the upfront costs. Perhaps more so! Knowing that you can comfortably cover ongoing housing expenses may put your mind at ease and help you focus on other financial goals, like retirement.

Mortgage Payments 

Mortgage payments generally consist of four distinct costs, known as PITI:^[4]

1. Principal. The amount to be applied toward repaying the balance of your home loan. 
2. Interest. The cost of borrowing money to purchase the home. 
3. Taxes. Property taxes levied by your local tax collector.
4. Insurance. Homeowner’s insurance premiums. Some private mortgage insurance policies with ongoing costs may also be included in the mortgage payment.

The principal and interest go directly to your lender. Your taxes and insurance go to an escrow account (if you are required or choose to have one). In this case, your loan servicer uses your monthly installments toward taxes and insurance to pay the respective bills as they come due.

Having a mortgage escrow account may benefit both you and your lender.^[5] You benefit from making predictable monthly payments rather than budgeting for larger quarterly, bi-annual, or annual insurance and tax bills. Your lender benefits from knowing that these important expenses are paid, which protects the asset they are invested in.     

Maintenance 

All homes require some level of regular maintenance. Deep cleaning, lawn care, repainting, air filter replacements, and pest control are common maintenance expenses that you should include in your homeowner's budget. 

Utilities

Many buyers forget to consider changes in utility costs. But the utility expense of your new home could be very different from the amount you currently pay for utilities. Consider the following:

• You may have a new provider for water, sewer, gas, trash, electricity, Internet, or any combination of these services in your new home. The new providers may have different rates than your current provider.
• Larger spaces may take more energy to heat and properly light. So you may use more electricity or gas in your new home, particularly if it’s substantially larger than your current place. 
• Your new home may come with energy-efficient appliances and features that you don’t currently have, which could potentially lower your utility costs.   

These utility cost changes might not be enough to make a difference in your overall finances. But, if you’re trying to budget accurately, you might want to do a bit of research on the potential utility costs of a new home. In some locations, the seller is required to disclose their monthly utility costs for the property. Check with your local real estate agent to see if this is applicable in your area.    

Any HOA Fees

HOA (Homeowner’s Association) fees help to cover the costs of community expenses, like the maintenance of pool areas and private roadways within the development. Every homeowner within the HOA is required to pay the set HOA fees as outlined in their HOA Agreement. 

These fees can range from a few hundred dollars per month for HOAs with limited common area expenses to over $1,000 per month for communities with more amenities.^[6] The seller is required to disclose these fees upfront.  

How To Determine A House Budget: Key Considerations 

With the upfront and ongoing costs of homeownership in mind, here is a list of the key factors that determine how much you can afford to spend on your new home.

Mortgage Interest Rates

Interest rates are the going cost to borrow money. And mortgage interest rates are constantly changing. You can check today’s mortgage rates to get an idea of the rate you might pay if you apply for a home loan in the near future. 

It is important to note that your specific mortgage rate will depend on a number of factors, including:

• The type of home loan you choose, 
• Your credit score, 
• Your level of debt, compared to your current income, and 
• The down payment amount. 

Here is a closer look at each of these factors, which are key considerations in both your interest rate and your house budget. 

Loan Type

There are five main types of home loans, each with different loan terms and interest rates. Choosing the best fit for you can help make homeownership more affordable. Furthermore, you may have different options within any single loan type. For example, you might choose a fixed-rate mortgage (in which the interest rate remains the same throughout the term of the loan) or an adjustable-rate mortgage (in which the rate fluctuates with changing market conditions). You might also choose the length of your loan term. Most mortgages are either 15- or 30-year terms, but you may have other options. 

Each of these decisions impacts your housing budget by changing your monthly mortgage payment.^[7] This is why it’s a good idea to discuss your options with a local home loan expert.    

Credit Score

Your credit score directly impacts your mortgage interest rate[8]. All other factors being equal, a higher credit score can earn you a lower interest rate, which can mean lower monthly mortgage payments. Many loan types are available to borrowers with a score of 620 or higher. But you may be able to secure a home loan with a score slightly below this mark. If you are not happy with your current credit score, there are ways to improve your score, including seeking credit repair assistance. 

Debt to Income Ratio (DTI) 

Your debt-to-income ratio compares your monthly debt payments to your gross (pre-tax) monthly income. This figure can serve as a helpful indicator of affordability. You may be more comfortable with your mortgage payments if your overall debt is a smaller percentage of your income. Simply divide your gross monthly income by your monthly debt payments (including the estimated mortgage payments for the new home) to determine your DTI.

Different loan types and different lenders have different DTI limits.^[9] For example, one lender may offer a 30-year, fixed-rate conventional home loan to qualified borrowers with a DTI of 36% or less, while another may require a DTI of 34% or less for the same loan product. Some loan types may allow for higher DTIs.   

Down Payment Amount

As discussed in the earlier section on the upfront investment of homeownership, the down payment is a major consideration for home buyers. The more you put down upfront, the less you have to borrow. And the less you borrow, the lower your monthly mortgage payments can be. 

But that’s not all. A higher down payment can also potentially lower your interest rate, helping you spend less on monthly mortgage payments.^[3] Plus, a higher down payment could prevent you from needing mortgage insurance, which would further reduce your monthly housing budget.  

Other Fees and Expenses 

Finally, don’t forget to ask your lender about other fees and expenses. There may be loan application fees, underwriting fees, processing fees, and/or administrative fees associated with originating the loan.^[10] In some cases, these fees may be paid upfront as part of your closing costs. In other cases, some of these fees may be rolled into the loan, allowing you to pay them over time as part of your mortgage payment.

The Importance Of Getting Pre-Approved For A Mortgage

Getting pre-approved for a home loan helps you house-hunt with confidence by confirming that you can qualify for the loan you need to purchase that new home. The pre-approval process involves having a lender review your financials to see how much you qualify to borrow and at what interest rate. This information can guide your search, helping you to focus on homes in your price range. 

Just as importantly, your pre-approval will show home sellers that you are a serious buyer, which could increase your chances of getting an offer accepted.^[11]

It's worth noting that a pre-approval can potentially take a few points off your credit score temporarily. This is because a "hard pull" of your credit history indicates an intention to take out a new loan, which would increase your level of debt. The effect is minor, but if you have any concerns about this, you can consider PNC's Premlinary Pre-Approval, which uses a "soft pull" of your credit history to avoid impacting your credit score.  

How To Get Pre-Approved For A Mortgage

You can apply for a mortgage pre-approval online. Simply visit PNC Bank’s website, and click the “Start Application Process” button. 

And if you’re not quite ready for that step yet, you can take a step closer to your new home by crunching your numbers on this Mortgage Affordability Calculator.