Navigating the all-important question of “how much should you spend on a house” can leave you feeling like Goldilocks in a room filled with porridge. You want to enjoy the home you live in, but don’t want to end up emptying your bank account each month to pay your mortgage. In the end, you just want to know if the price tag on that home you’ve been eyeing is too hot, too cold, or just right.
This is How Mortgage Professionals Figure out What Your Finances Will Allow You To Qualify For (in a Nutshell)
The answer obviously varies on a case-by-case basis and it varies a lot. But, in the eyes of mortgage professionals the answer technically comes down to something referred to as DTI, or debt to income ratio. In the simplest of terms, DTI is a comparison of the money you earn and the money you spend. The spend side of the equation includes all recurring debt expenses, such as housing costs (for the sake of determining how much house you can qualify for, they use your projected mortgage payment), car payments, student loans, and credit card debt. Your debt expenses are divided by your gross income and the resulting decimal is multiplied by 100 to create your DTI percentage.
What the Numbers Tell You
As a very simple example, imagine that you earn $1,000 per month and your monthly debt adds up to $400 per month. 400 divided by 1000 is 0.4. Multiply that by 100 and you can see that your DTI would be 40%.
So, how do you know if your projected DTI is “good enough” or not? In general a home buyer needs a DTI ratio of no more than roughly 43% to qualify for a conventional mortgage, but a lower DTI ratio may be required to qualify for certain rates, terms or loan programs. Plus, the lower your DTI, the smaller the chance you’ll have to sacrifice your quality of life or be unprepared for a possible financial emergency later on.
In other words, the lower your DTI percentage, the more money you’ll have to spend on things outside of bill-pay. A lower DTI percentage means it may be easier for you to save money, go on vacation, or buy those cool kicks you’ve had your eye on while still living in a home you love.
How Much Should I Spend on a House?
As mentioned above, you likely would need a DTI of no more than roughly 43% to qualify for a conventional mortgage loan.
How does that translate to the overall cost of a home? David Weliver of Money Under 30 explains that while you won’t be able to determine an exact budget until you know the interest rate, points, fees, taxes, and insurance related to your home purchase, you can still create a general estimate of your budget. If you assume a 6% interest rate on a 30-year fixed-rate mortgage, your monthly principal and interest mortgage payments will be about $650 for every $100,000 borrowed.
So, in order to estimate a budget, if your preferred DTI were 43% (for your mortgage payment only), you could take 43% of your monthly income, divide that number by $650 and multiply that number by $100,000.
($430/$650) X $100,000 = $66,153
In this situation, your maximum mortgage amount would be $66,153.
Add that number to your planned down payment and you know how much you can spend on a house. Returning to our example, if you were planning to put $10,000 down, your total home purchase price would be $76,153 (10,000 + 66,153).
But, remember that this sample calculation doesn’t include other debts or expenses. It can be an important step to factor in those other financial components as well…
Make Your DTI Work for You
Keep in mind that these percentages and dollar amounts are just hypotheticals and generalizations and that these materials are intended for educational purposes only. They are not intended as financial advice. You are encouraged to talk to mortgage and/or financial professionals.
And, your perfect bowl of porridge might differ from a general recommendation. Though you may want to buy the most house you can afford and thereby push your DTI toward the maximum for a conventional loan, many home purchasers opt for a lower mortgage payment to allow for growing retirement funds or to cover unanticipated bills or other expenses not accounted for in a DTI calculation.
You might consider adding up all of your expenditures (including earnings and savings activities) on a monthly basis, then seeing what’s left over from your paycheck.
Once you know what’s available for your monthly mortgage payment, and assuming a fixed 30-year interest rate loan of 6%, you can just divide the amount of income you have left by $650, multiply that by $100,000 and add your planned down payment to determine how much you can spend on a home.
A Good Way to Estimate Your Home Budget:
- Add up all of your monthly expenses
- Health and medical expenses
- Gift purchases
- Car payments
- Insurance payments
- Water & heating
- Loan & credit card payments
- Monthly savings contributions
- HOA payments
- Subtract that total from your monthly income
- Divide that remainder by 650 (assuming a fixed 30-year interest rate loan of 6%)
- Multiply that number by 100,000
- Add that product to your planned down payment
- You’ll have a good estimate for your new home budget that fits your lifestyle
Your Just-Right Home Price
How much should you spend on a house? It all comes down to what you spend… on everything else. Compare that with what you earn and you’re on the right track to answering that very big question. But one thing’s for sure, running all your numbers and talking to a mortgage professional will get you much closer to a home that Goldilocks would be proud of and a monthly mortgage payment that’s just right.