Just because a lender approves you for a mortgage doesn’t mean you can comfortably afford it.
If you ask Google “How much house can I afford?” you’ll find a number of online tools and mortgage calculators to help you find a fast answer. You might also find quick but somewhat confusing advice like “Your mortgage payment shouldn’t take up more than 35% of your monthly income.”
Quick. Do you know what 35% of your monthly income is? If not, you’re not alone. While online housing tools are a helpful starting point for the early stages of your house hunt, it’s important that you understand how the pieces all fit together, and that you take your personal financial situation into account.
Why a calculator can’t tell you how much house you can afford
1. Financial rules of thumb may not apply to you
While 35% seems like a straightforward figure, your financial picture is a lot more complicated than that number would make things seem. Your ideal monthly housing costs could vary depending on things such as debt and other monthly payment obligations — not to mention how much you’ve saved for a down payment.
If you have high credit scores and a clean financial background, a mortgage calculator can be a great starting point for mortgage shopping. You’ll get a much better sense of what your price range might be instead of a blanket rule of thumb. But they’re only as accurate as the information you provide, so if you forget to add regular budget line items such as food, day care, or gas costs, you won’t get a complete picture.
2. Your lender may approve you for more than you can realistically afford
Lenders are now legally required to ensure borrowers can “reasonably afford” to repay a loan before they approve a new mortgage. But there’s a difference between being able to reasonably afford something and being able to realistically afford something.
When looking at what’s reasonable, lenders account for your income and any current debts that you need to repay each month. If you make $ 5,000 per month after taxes and need to pay $ 500 toward your car loan each month, a mortgage payment of $ 1,500 may seem perfectly reasonable.
In this (extremely simplified) example, you’d have about $ 3,000 per month left over to handle all your other expenses. And perhaps you can afford your living expenses on this budget.
But what about the other goals you want to achieve? What about saving for retirement or investing for your future?
If you commit to a large monthly mortgage payment, you may find yourself squeezed to make your remaining money cover your living expenses, plus monthly bills and loan repayments. While a lender can give you a mortgage you can reasonably afford, it could mean not being able to handle other financial priorities.
3. You’re the only one who can determine what’s comfortable
Only you can examine your life and values to determine what you are willing to spend on your mortgage budget — and what you’re not.
You might be perfectly happy to take on a larger monthly mortgage payment in exchange for reducing meals out, cutting back on vacations, or sticking with your old phone instead of going for the upgrades just because you can. Or you may decide that renting makes more sense for you because you can mitigate costs, take on less financial responsibility, and enjoy more flexibility.
Either way, you need to determine what you feel comfortable with. You need to decide what works within both your budget and your long-term plans to reach goals that matter to you.
Ask yourself four questions to decide how much house you can really afford
Once you set your financial priorities, here’s where you’ll need to do the math:
- What’s my current income? What are my basic living expenses? What are my fixed costs?
- How much do I want to put away each month into savings or investments?
- How much will it cost to maintain my new home?
- What kind of down payment do I have? (The more you put down, the smaller your monthly mortgage payment will be.)
Now you can factor a mortgage into all of the above, and see how much you can really afford. When doing so, don’t forget to count both the mortgage principal and interest — along with property taxes, homeowners’ insurance, and other extras such as HOA fees.