The price of the home you can afford equals your down payment plus the mortgage amount you qualify for. In short, your down payment is the amount of money that you contribute to buy a home that you are not required to pay back. Your down payment represents the smaller component of the funds used to buy a home with most people make a down payment between 3% and 20% of the property purchase price, although some mortgage programs require no down payment. Your down payment can come from your personal funds, a gift from a relative or friend or from a down payment grant or other assistance program. The amount of your down payment depends on your financial resources including your savings and investments or the size of the gift or grant you receive.
Your mortgage comprises the majority of the funds used to buy a home, usually between 80% and 97% of the property purchase price. Your mortgage is the money you borrower from a lender that you are required to repay over a certain period of time, plus interest which compensates the lender for loaning you the money. What size mortgage you qualify for depends on multiple factors including your monthly gross income and debt expense, interest rate, mortgage program and loan length.
Adding your down payment to your mortgage amount determines how much home you can afford, keeping in mind that are also required to pay closing costs and potentially hold savings in reserve when your loan closes, so you may need to come up with additional funds to complete the property purchase. We review how your down payment and mortgage impact what price home you can buy in detail below.
The down payment is money that you contribute to purchase a home. So if something unfortunate happens such as selling your home for less than you paid for it or your home going into foreclosure, you could lose part or all of your down payment. Most people use personal funds from a bank, brokerage or investment account as the source of their down payment. Other potential sources of money for your down payment include a gift from a relative, friend, fiance or domestic partner. Please note that lenders have strict guidelines about documenting down payment gifts to ensure that any funds you receive are truly a gift and not a loan that needs to be repaid.
You can also use a down payment assistance program or employer home buyer assistance program to pay for all or part of your down payment. These programs are usually structured as grants or second mortgages that you do not need to repay if you own the home for a pre-determined period of time, usually three to five years. In some cases you are required to repay the down payment assistance grant, plus deferred interest, when you sell your home or refinance your mortgage.
Whatever the source of funds for your down payment, the most important point is that the higher your down payment, the more home you can afford. For example, with a $20,000 down payment and an $80,000 mortgage, you can afford a $100,000 home. With a $30,000 down payment and the same $80,000 mortgage, you can afford a $110,000 home. Simply put, if you are willing to make a large down payment, you can buy a more expensive home.
In some cases, making a larger down payment also enables you to qualify for a larger mortgage amount which increases how much home you can afford. For example, most lenders offer you their lowest mortgage rate if you to make a down payment of at least 20%. Paying a lower mortgage rate enables you to afford a higher loan amount which boosts what price home you can buy, so your down payment and mortgage can work together in some cases.
While it is certainly possible to buy a home with a down payment of less than 20%, you may be required to pay a higher interest rate or mortgage insurance, which is an extra monthly cost on top of your loan payment. Paying a higher rate or mortgage insurance reduces the loan amount you qualify for and how much home you can afford. Making a down payment of less than 20% should not deter you from buying a home; however, as there are multiple no or low down payment mortgage programs available to qualified applicants. A smaller down payment just means that you may need to adjust your home price budget.
The second piece of the home affordability equation is your mortgage. What size mortgage you can afford is based on your monthly gross income and debt expenses, interest rate and loan term. Typically, lenders permit borrowers to spend a maximum of 43% to 50% of their monthly gross income on total monthly housing expense plus other monthly debt payments. Total monthly housing expense includes your mortgage payment plus property tax and homeowners insurance (also known as PITI) as well as other potential costs including homeowners association (HOA) dues and mortgage insurance. Other monthly debt expenses include payments for credit card, auto, personal and student loans as well as alimony and child support payments, if applicable.
The ratio of your monthly debt expenses to your gross income is your debt-to-income ratio and lenders use this figure to determine what size mortgage you can afford. We should highlight that your debt-to-income ratio is based on your monthly gross income, or your income before any deductions. Additionally, the debt component for your debt-to-income ratio is based on your monthly debt payments, and not your loan balance.
The example below demonstrates how a debt-to-income ratio is applied to determine what size mortgage payment you can afford. In the example, we apply a 50% debt-to-income ratio to the borrower's $6,000 monthly gross income and then subtract $450 in non-housing related monthly debt payments (think credit cards, car and student loans) to calculate how much the borrower can spend on total monthly housing expense ($2,550). We then subtract $400 in property tax and homeowners insurance to determine that the borrower can afford a monthly mortgage payment of $2,150. Applying a lower debt-to-income ratio reduces the mortgage payment the borrower can afford.
We should emphasize that the less monthly debt you have, the higher the mortgage payment and larger the mortgage you can afford. Applying this to home affordability, the higher your loan amount, the higher the price home you can buy. So in example below, if the borrower has less than $450 in monthly debt, he or she can afford a larger mortgage amount and a higher priced home.
The chart above shows that the borrower can afford a $2,150 monthly mortgage payment. What size mortgage and home you can afford based on that monthly payment depends on your interest rate and the length of your loan. Below, we show the mortgage amount the borrower can afford based on interest rates of 4%, 5% and 6%. This example demonstrates the lower your interest rate, the higher the mortgage amount and home you can afford. Additionally, the longer your mortgage term, the higher the loan amount you qualify -- this is one reason why most people select 30 year loans.
Returning to the original question of How Much Home Can I Afford?, the answer remains the mortgage you qualify for plus your down payment. The table below outlines down payments of 5%, 10% and 20% and shows what price of home you can buy assuming a $450,000 mortgage. In this example, a down payment of 20% equals $112,500, which when added to a $450,000 mortgage means you can buy a $562,500 home. As demonstrated by the table, the higher or lower the down payment you make, the more or less home you can buy.
This example provides a framework for determining how much home you can afford but the most important rule is to select a down payment, loan amount and home price that you are comfortable with over the long term. Make sure that your total monthly housing expense fits within your budget and do not over-extend yourself financially. Getting a mortgage and owning a home you cannot afford are common mistakes committed by both first-time and experienced home buyers. Ultimately, you decide the home purchase price that is right for you based on your individual circumstances and financial profile.
The table below compares mortgage rates and fees for leading lenders in your area. We recommend that you contact multiple lenders to determine the mortgage amount you qualify for and to compare loan proposals. Shopping for your mortgage enables you to save money and find the lender and loan that best meet your needs.
Review our instructional video below to learn more about how much home you can afford.
“How can I figure out if I can afford to buy a home and take out a mortgage?” CFPB. Consumer Financial Protection Bureau, February 24 2017. Web.About the author