How to Calculate Your Maximum Home Price
The most important factor in determining the maximum home price you can afford is your monthly debt-to-income ratio, or DTI. Your DTI tells you how much of your income goes toward your monthly debt payments, including your mortgage, car payments, credit card bills, child support, or student loan payments. The higher your DTI, the less money you’ll have to put toward your down payment and closing costs when buying a house. The lower your DTI, the more cash you’ll have available to get the house of your dreams. To calculate the maximum home price you can afford, take your monthly income and divide it by your total debt payments and other recurring monthly expenses, like health insurance or child care.
The Role of Your Credit Score
Your credit score is a number that lenders use to determine your creditworthiness and risk of default. Lenders also use your credit score to determine the interest rate you get on a mortgage. The higher your credit score, the lower your interest rate. The lower your credit score, the higher your interest rate. If your credit score is below 620, you’ll likely be required to pay a higher interest rate on your mortgage. If you’re planning to purchase a home with a low credit score, you may want to consider taking steps to improve your credit score before applying for a mortgage. Your credit score can change over time, so it’s important to check your score at least once a year. You can view your free credit score and report on Credit Karma. Credit Karma also offers free guidance from certified credit counselors who can help you create a plan for improving your credit score.
What to Do if You Can't Afford the Maximum
If you can’t afford the maximum home price you’ve calculated, the first step is figuring out where you can make cuts in your budget. If you have high-interest debt such as credit card payments, a car loan, or a student loan, consider paying those off before buying a house. Once you’ve cleared those debts out of the way, it’s time to reset your monthly budget. Now that you have a cleaner financial slate, it’s time to figure out exactly how much you can afford to spend on a house. Start by calculating your monthly debt-to-income ratio, then subtract your debt payments, recurring expenses, and savings. Once you have your monthly budget, plug that number into a mortgage calculator to find out the maximum home price you can afford.
Preparing for the Home Buying Process
Before you start house hunting, make sure you have the following items ready to go:
- Credit score: As discussed above, your credit score is the most important factor in determining the amount of house you can afford. If your credit score is below 620, your lender may require you to pay mortgage insurance. If your score is below 600, you may not qualify for a mortgage loan at all.
- Debt-to-income ratio: As discussed above, your DTI is the percentage of your gross monthly income that goes toward your debt payments.
- Down payment: The larger your down payment, the better. The vast majority of lenders require a down payment of 20% or more. The only exception is the VA loan, which allows a down payment as low as 0% for service members and veterans.
- Emergency fund: It’s important to have at least 6 months of savings in an emergency fund to handle expenses like a car repair or medical bill. You’ll also want to set aside money for closing costs and home inspections.
Mortgage Pre-Approval
Before you start house hunting, it’s a good idea to get pre-approved for a mortgage loan. Pre-approval is when a lender evaluates your financial situation to determine how much money they’re willing to lend you. Getting pre-approved for a mortgage loan will give you a better idea of how much house you can afford. Getting pre-approved will also help you budget more accurately because you’ll have a specific amount of money to work with. While you don’t have to buy a house on the first day you’re pre-approved, it’s good to get the process started as quickly as possible. The sooner you get pre-approved, the more time you’ll have to look at houses. It’s also a good idea to shop around and compare mortgage rates before you start looking at houses.
Other Costs to Consider
When calculating how much house you can afford, remember to include all the costs associated with buying a home. Here are a few things you should add to your budget:
- Mortgage payment: The amount you’ll pay every month for your mortgage.
- Home insurance: Homeowners insurance covers damages to your home, as well as liability for injuries that occur on your property.
- Property taxes: Property taxes are annual taxes paid to your state or local government in exchange for living on and using public land.
- Maintenance: Maintenance costs are common expenses homeowners face. They include things like yearly roof repairs, HVAC maintenance, and appliance repairs.
- Home improvement costs: Home improvement costs are expenses you can incur throughout your home’s lifetime.
Tips for Sticking to Your Budget
If you’ve calculated the maximum home price you can afford and you’re still falling short, it may be time to take a step back and reassess your budget. Here are a few tips for keeping your expenses down and sticking to your budget:
- Shop around and compare mortgage rates: There are plenty of online mortgage calculators and apps that help you shop around and compare mortgage rates.
- Get creative with your down payment: If you don’t have enough saved in your emergency fund to cover a 20% down payment, there are other ways to get a mortgage. You can get a mortgage with no money down by using a co-signer or a mortgage insurance policy.
- Don’t overextend yourself: Buying a house is an exciting and rewarding experience, but it’s important to remember you don’t have to buy the most expensive house on the block.
