How Much House Can You Afford?

I have been receiving phone calls this morning from clients that have heard the interest rates are dropping, and are wondering if it is now a good time to purchase a home.  Their first concern is how much they should be spending on their new home purchase.

The first step is figuring out how much you and your partner or co-buyer earn each month, including all revenue streams, from rental earnings and investment profits to alimony.

Next, determine housing costs including property tax, homeowner's insurance and mortgage payment. The payment can be determined by estimating the mortgage interest rate, principal, down payment and term of the loan.

Most financial advisers agree that spending no more than 28 percent of your gross monthly income on housing expenses, and no more than 36 percent on total debt (including student loans, credit card payments and auto loans) is a good baseline for what you should be able to afford on a monthly basis.

Your debt to income ratio compares your monthly income to your monthly debt.  This is important because most lenders will not consider a borrower with a DTI above 43 percent. For borrowers, it is a good idea to pay off as much debt as possible prior to applying for a mortgage to improve your DTI.  The higher your DTI, the harder it will be to obtain a mortgage, and you will also have to settle for a higher interest rate.

It is also important to note that if your down payment is less than 20 percent, you will have to pay private mortgage insurance.  This can add to the cost of your monthly payment, and can range from .5% to 1% or more of the loan amount. Please contact me if you are interested in scheduling a Financial Strategy session to help you determine what you can afford to spend on a home.

About the Author

Patti Hughes is a Chicago Fee-Only Financial Planner.  Lake Life Wealth Advisory Group provides comprehensive and objective financial planning, retirement planning, and investment management to help clients organize, grow and protect their assets through life’s transitions.  She is a fiduciary, and does not sell products or earn commissions, so she truly acts in the best interests of her clients.