Buying a home is an exciting adventure but before you start looking for that perfect place, it’s a good idea to decide how much you should spend.
This can be different than the most expensive home you can afford. Lenders often approve a mortgage up to a maximum amount based on your current credit, income, debts, and finances. For example, a lender might approve you for a mortgage worth $350,000. If you have $50,000 saved for a down payment, this means you might be able to buy a $400,000 house.
But just because you can buy a house that costs $400,000 does not necessarily mean you should buy a home for that price. When you buy the most expensive house you can afford, you’ll have higher payments and less money for other monthly bills and expenses. If you use all your savings on a down payment, you could have less cash available for emergencies. Also keep in mind that buying a home comes with closing costs, which you will either need to pay in cash or add to your mortgage amount.
You might instead decide that homes that cost between $300,000 and $350,000 are a better choice for you. Think about the items below, look at your budget, and then make your decision!
How much should you spend on your house payment?
Your monthly house payment includes more than just interest and principal. You will also need to account for:
- Property taxes. Most mortgages require you to make payments toward your property taxes each month. Research property taxes for the houses you are considering and add this to your estimate. The property taxes on a $400,000 house are likely to be higher than those on a $300,000 house.
- Homeowners insurance. Most lenders will require you pay for homeowner’s insurance as part of your monthly bill too. Insurance costs vary by state and community, but the national average is $1,249 a year according to the National Association of Insurance Commissioners (NAIC). Just like with property taxes, more expensive homes tend to have higher homeowners insurance costs.
- Mortgage insurance. Many loans require mortgage insurance and these costs are part of your monthly payment too. Two exceptions are when you buy a home with a VA loan, which does not require mortgage insurance and conventional loans when your down payment is at least 20%.
You can use our mortgage payment calculator to help you estimate how much your monthly payment will be. The calculator considers the purchase price of the home as well as your mortgage amount, interest rate, property taxes, and homeowners insurance. Change the values to change your estimate.
How much do you earn and how much do you spend?
After you’ve looked at estimates for your monthly house payment, then think about all your other monthly debts and expenses:
- Monthly gross income. This is your earnings for the year before taxes and deductions are taken out.
- Debts. These are recurring expenses you pay off monthly like a car payment, credit card or college loans.
- Utilities. Owing a home often comes with bigger utility bills for electricity, heating and cooling, water, internet, and more. Ask the real estate agent or the seller if they have an estimate of the monthly utility costs of the home.
- Home repair. Owing a home also comes with expected and unexpected repairs. Having an emergency fund with cash ready for surprises is a good idea.
- Saving for retirement & college. It’s a good idea to start saving for retirement as early as you can. If you have kids, you may want to include child-care expenses or saving for their college educations too in your budget.
- Income taxes. Part of your monthly gross income probably goes to paying income taxes.
- Your lifestyle. Review your spending habits including cell phone and TV/Internet services, entertainment, eating out, clothing and food to get a better picture of how much you spend each month. You want to make sure you build in these expenses to have an accurate amount you can work with for a monthly house payment. Buying the most expensive home you can afford often means you have to cut back in other areas of your life.
A good way to look at the big picture of your monthly spending is to calculate your debt-to-income ratio, which you get by dividing your total monthly debt payments by your gross monthly income. Generally, lenders prefer a debt-to-income ratio below 36%. This means you are only spending 36% of your monthly gross income on all your debt payments including your house payment.
This leaves 64% of your monthly gross income for all your other expenses, which is a reasonable rule of thumb for many people. Many lenders require that you have a debt-to-income ratio no higher than 36%, which means this is an important number to know when you are trying to get approved for a mortgage.
By taking a holistic view of your finances you can get a clearer picture of how much you should spend on a home. Becoming a homeowner is a big, exciting step, so you want to make sure you properly plan for the financial commitment that homeownership brings.