Interest rates play a vital role in calculating your home’s affordability. The interest rates have risen significantly from below 4% in January 2022 to a fluctuating bracket of 6%-7% in September 2023. Due to this, house affordability has become difficult, especially when the supply isn’t able to keep up with the demand.
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Additionally, other factors such as down payment, annual income, and other debts like car loans, education loans, etc. play a significant role in calculating your home affordability. Learn how much house you can afford without being house-poor.
📉 Key Takeaways
- 28/36 Rule: The 28/36 rule is a home buying rule of thumb. It allows you to find how much house you can afford.
- The Good Neighbor Next Door Program: This program is run by the Department of Housing and Urban Development. The program provides a 50% discount on list price of a house to select professionals.
- Loan Assistance: Loans like the FHA loans, USDA loans, and VA loans provide buying assistance to first-time buyers.
Factors that Affect Home Affordability
There are a number of factors that affect a home’s affordability:
Annual Income
Annual income is the gross income that you earn in a calendar year. Suppose you’re buying a house with a co-borrower and decide to apply for a mortgage. The annual income will be your and your co-borrower’s total. This information is typically available on your W2 form.
Total monthly debts
These are the recurring payments like credit card bills, tuition expenses, car loans, etc.
Down payment
The money paid upfront to purchase a house is called a Down Payment. The majority of home loans mandate a 3% down payment. However, paying a 20% down payment increases home affordability and lowers your monthly payments.
» How Much Down Payment for a House: Read to know more.
Debt-to-income ratio (DTI)
DTI indicates the fraction of income spent on debt payments. Total monthly debt payments divided by the total monthly gross income give you the DTI. Lenders use DTI to evaluate your repayment capacity. Usually, lenders accept a DTI below 36%, but some lenders allow up to 43% as well.
Interest rate
An Interest rate is the charge that a lender charges a borrower. Your monthly payments are calculated based on this rate. The borrower pays monthly installments with interest to the lender until the full repayment. Your interest rate depends on your credit score.
The current average rate for a 30-year fixed mortgage is 7.55% and for a 15-year mortgage is 6.97%.
Loan term
The time period in which you agree to pay back the loan. Typically, this term is for 30 years or 360 months. However, multiple options are available based on the type of loan and situations that suit you best:
- 10-year Mortgage
- 15-year Mortgage
- 20-year Mortgage
- 25-year Mortgage
- 30-year Mortgage
Mortgage terms that last for a period of 10 to 15 years are considered short-term mortgages. Whereas, long-term mortgages are for 20 years or more.
Additional Expenses
Expenses such as Homeowner’s insurance, property tax, and Homeowner’s Association fees collectively play an important role in your house affordability as they are paid on a monthly basis.
- 👉 Follow the 28/36 Rule: The rule suggests that you shouldn’t spend no more than 28% of the total gross monthly income on home expenses, and no more than 36% on total debt. The rule sets a standard for how much you can afford to pay every month.
3 Steps to Find Your Housing Affordability
The below steps explain how you can find your home affordability:
- Find Out Your Total Income: Determine your monthly household income including your partner’s income. Include all of your sources of income like alimony, investment gains, and rental income.
- Estimate Your Housing Costs: Include your projected monthly mortgage payment and total down payment. Include the cost of homeowners insurance, projected mortgage interest rate, loan term, and annual property taxes.
- Tally of Your Overall Expenses: This is the total amount of money that is spent each month. Be thorough with your spending because this has a significant impact on the amount you can afford to put down on a home.
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Ways to Improve Home Affordability
Learn how you can improve your home affordability:
Downpayment Assistance
DPA only assists in downpayment, not for closing costs or the home’s purchase price. There are other programs for assistance with closing costs of buyers.
Typically, DPAs cater to the needs of first-time home buyers. This doesn’t mean that if you already own a house you won’t get the assistance. It depends on your income and the neighborhood where you want to purchase the house.
There are more than 2,000 active DPA programs across the country.
Special Mortgage Types
There are professions that enjoy special mortgages. These are generally front-line workers like firefighters, first responders, and public servants like teachers, and doctors. Some countries provide special loans to government officials as well.
The Department of Housing and Urban Development (HUD) runs a “Good Neighbor Next Door Program“. This program provides a 50% haircut on the list price of a house to Law enforcement officers, firefighters, teachers, and emergency medical technicians.
🚨The occupants must live in the space for at least 36 months. The only catch is that the house will be located in a revitalization area, an unpleasant neighborhood to live in.
Closing Cost Assistance
Closing costs are one of those out-of-pocket expenses that disrupt your housing budget. Typically, DPAs help close costs, but that’s not the only way. However, in some cases, sellers can be of help.
- In the case of a buyer’s market, you may get seller concessions in the form of closing cost assistance, extra discounts, etc.
- Another way is lender credits. Here you are supposed to pay a higher-than-usual mortgage rate in return for zero or minimal closing costs.
Government Loans
The government promotes housing for its citizens. To solve housing problems, the government provides various types of loans such as:
- Federal Housing Agency Loans (FHA loans)
- US Department of Veteran Affairs Loans (VA Loans)
- United States Department of Agriculture Loans (USDA Loans)
Bottom Line
It is important to determine how much house you can afford. Ways such as the 28/36 rule, calculation of the down payment, evaluation of your financial standing, and more can help you identify the best house for yourself.
Moreover, there are various assistance programs such as DPAs, special mortgages, and closing cost assistance through which you can manage your home-buying budget.
» Average Mortgage Payment: Read to know more.
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Frequently Asked Questions (FAQs)
1. What house can you afford with a $ 100,000 salary?
You can afford a home between $300K to $400K if your annual salary is $100K assuming your Debt-to-Income ratio and creditworthiness is favourable.
2. What credit score is needed to buy a $300K house?
Most conventional lenders require a credit score of 620. However, to get an FHA loan you need a credit score of at least 580 with a 3.5% down payment. This means you have to pay $10,500 as the minimum down payment for a $300K house.
3. How much money do I need to make to afford a $500K house?
As per the 28/36 rule, you will at least have to make $14,200 (including taxes and insurance) every month to afford a $500K house.
4. What are the ufront costs of buying a house?
The upfront costs of buying a house include a down payment and closing costs like appraisal, real-estate attorney fees, mortgage insurance, and more.
5. How much house can I afford based on my salary?
To calculate your house affordability, follow the 28/36 rule. The rule states that you shouldn't spend more than 28% of your gross monthly income on home expenses. And 36% of your gross monthly income on overall debt payments.
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