How Much House Can You Actually Afford?

If you’re starting the process of shopping for a home, odds are you’ve been planning for this moment for a long time. You’ve probably been building up your down payment, paying off your debts, and even checking out some listings in your preferred city or neighborhood. It’s an exciting milestone, and it’s worth celebrating. 

It’s also a good time to think through an important question: How much can you actually afford to spend when purchasing your home? Setting a housing budget that fits your personal situation is important—not only will it help you target listings, but it will also help you make sure you have enough left over for your other goals (whether that’s retirement, a new car, or sending a child to college). 

There are some standard ways you might start to answer this question, but they have limitations. Online calculators can help you get a simplified estimate, but they lack important context on your unique situation and preferences. Your preapproval letter (when you get one) will use a standard formula to tell you the maximum amount a lender is willing to loan you, but that doesn’t mean it’s what you should spend. And your best friend with a similar income isn’t a good benchmark either, because the most important factor is what you are comfortable with. So where should you begin?

Here’s the short answer: To figure out how much house you can afford, start by calculating a comfortable down payment and monthly payment, and use those numbers to back into a home value. Avoid the temptation to spend every penny, and make sure to factor in other large expenses.

Read on for a more detailed explanation. 

Start with your down payment

Your down payment is your initial, up-front investment in the home. The size of your down payment impacts your interest rate, whether or not you need private mortgage insurance (PMI), and how big your monthly payments are. 

Conventional wisdom is to make a down payment of at least 20% of your home’s value to avoid mortgage insurance (which is an added cost). But you can put down much more or much less depending on your unique situation. Some buyers put down as little as 3%, and average first-time home buyers put down about 9%. A larger down payment can sometimes get you a lower interest rate from a lender.

• Conventional wisdom: A 20% down payment is a reasonable starting point for many people, but it’s not right for everyone. 
• When to adjust: 
  • Putting down more than 20% could make sense if you have significantly more cash on hand and want to reduce your monthly payments or potentially get a lower rate.
  • Putting down less than 20% could make sense if you are comfortable with larger monthly payments and want to minimize your up-front costs. Maybe you’d rather invest the money, for example, because you think you can earn a much higher rate of return than the rate at which your home will appreciate. Maybe you want to stay very liquid for home improvements, or maybe you’re sending a child to college soon. There are multiple reasons you might choose this option.

Think through your monthly payments

Once you know roughly how much money you plan to put down on a home, it’s time to start thinking about your monthly payments. These payments will include mortgage principal and interest along with property taxes and homeowner’s insurance (depending on how you choose to handle them, although you’ll need to budget for them either way) and HOA fees if applicable. This calculator from Fannie Mae can help you estimate your monthly payments—just be sure to click on “Advanced View” and factor in those costs as well. 

• Rule of thumb: Historically, the guidance has been to spend no more than 30% of your pre-tax income on housing. This suggestion originated in 1969, when rent in public housing projects was capped at 25% of income. The US Department of Housing and Urban Development raised the cap to 30% in 1981. 
• When to adjust:
  • Spending more than 30% of your pre-tax income on housing each month might be OK if your income is very high. That’s because some of your other non-housing costs might be fixed and represent a smaller chunk of your income. It might also make sense if you live in an area with a high cost of living, or if you expect your income to continue to increase over time. If you have no other debts, a lender will generally preapprove you for monthly payments that comprise up to 43% of your pre-tax income, but it’s up to you to decide if you feel comfortable handling the monthly payment.
  • Spending less than 30% of your pre-tax income on housing each month could make sense if you like having a big financial buffer or are saving for other large financial goals.

Leave yourself a comfortable buffer

A word of warning: When you’re buying a house, it’s smart to leave yourself a good amount of buffer. That means not spending every penny on your down payment and not committing to a monthly payment that you know will put a lot of pressure on you.

You should still leave yourself at least enough wiggle room to cover the following items:

• An emergency fund (with at least 3-6 months’ worth of expenses)
• Your regularly occurring and short-term expenses (groceries, bills, next month’s vacation, any debt you’re paying off, etc)
• Saving/investing for other long-term goals, like a wedding or child’s education 
• Saving/investing for retirement 
• Home repairs and maintenance. Things will break! Consider setting aside 1% of your home’s purchase price to fix them.

Putting it all together

Once you’ve calculated a rough down payment and monthly payment, you can use those numbers to approximate a housing budget.

For example, let’s imagine you have $100,000 saved for a down payment, and you’ve determined that you’re comfortable with a monthly housing payment of $3,000 (which includes all of the costs we discussed in the “monthly payments” section above and leaves you a sufficient financial buffer). Here’s how you might put that together: Assuming you want to put down 20%, a $100,000 down payment implies a total home price of $500,000. This means you’d be borrowing $400,000. Use a calculator like this one from Fannie Mae to make sure you’re comfortable with the associated monthly payments. (You can use additional online calculators to estimate your property taxes and homeowners insurance.) If your monthly payment comes out to $3,000 or less, you’re in the ballpark. If not, try adjusting the loan amount down until you land on a payment you’re comfortable with. 

It’s also important not to forget about closing costs, which are often around 2% of the total home price. In this example, 2% of $500,000 would be $10,000. This means you would want to budget for about $10,000 in closing costs due up front in addition to your down payment. If the extra $10,000 stretches your budget too far, you can consider a smaller down payment and update your plan accordingly.

Don’t forget about interest rates

As you probably know, prevailing interest rates for mortgages can have a big impact on your housing budget. We’ll illustrate this with a quick example. Let’s assume you’re putting 20% down on a $500,000 house and taking out a 30-year fixed-rate mortgage. Ignoring the impact of taxes, insurance, and HOA fees, here’s a simplified illustration of the difference various interest rates (which do not represent actual rates) would make on your monthly payments:

• 5% mortgage rate: $2,147 monthly payment
• 6% mortgage rate: $2,398 monthly payment
• 7% mortgage rate: $2,661 monthly payment

All other things being equal, you will probably be able to afford a more expensive home when interest rates are lower. Conversely, when rates are high, they will put more pressure on your monthly payments.

Stick to your number

We hope this guide helps you think through how much house you can afford. A reminder: Your housing budget is primarily a function of what you are comfortable with. Don’t be swayed by friends, family members, or even your preapproval letter. If you’re not comfortable with the payments, then it’s not a good idea.