HOW MUCH HOUSE CAN I AFFORD?

"How much house can I afford?" It's a question asked by millions of people every day, and the answer is, "it depends."

If you're paying rent right now on an apartment, chances are you can afford to make house payments. This assumes that you don't have bad credit or a high amount of debt.

How much house you can afford depends upon a number of factors, including your income, debts, credit history, and how great a house you want or how inexpensive a house you're willing to settle for.

Rather than pull numbers only from a calculator, let's look at the lifestyle you have, and then ask "how much house can I afford" based upon how much you're willing to change your lifestyle. Simply using a calculator doesn't tell you how much house you can afford while still being happy.

First, put your monthly budget down on paper. Include your credit card payments, car payments, consumer loan payments, student loan payments, alimony, child support, or any other regular monthly debt payments. Also include in your monthly budget your other expenses, including food, entertainment, auto repairs, doctor bills...in short, everything you spend money on.

Write down your monthly income before taxes. This should be based upon your tax return for last year, as your last two years' tax returns will be what the lender will use to qualify you.

We're going to use two numbers now to figure out how much house you can afford. The first number is 28%, which is the percentage of your monthly income before taxes that lenders consider to be the maximum you should be putting toward a house payment. Some lenders will go a little higher than 28%, and some lower, but let's use 28% as the standard.

You now have the amount of house payment that you can hypothetically afford. This includes taxes and insurance. If your monthly income before taxes is $4000, you can afford a house payment of $1120 a month including taxes and insurance.

But there's also your debts, so the second number you need to keep in mind is 36%. This is the percentage of your monthly income before taxes that lenders consider to be the maximum amount for your house payment and other regular debts combined. Again, some lenders will be slightly higher, and some lower.

Assuming a $4000 a month pre-tax income, your total of house payments, taxes, and insurance, plus regular debt payments such as charge cards, car payments, etc, should not exceed $1440.

Now it's time to go back to your budget sheet. From the 36% amount you arrived at, subtract the regular monthly debt payments. For credit cards, use the minimum monthly payment shown on your statement. After subtracting your monthly debt payments, the amount you have left is what you can afford to pay on a mortgage. Let's say that, after subtracting your car payment and credit card payment from the hypothetical $1440 amount above, you're left with $1000.

So, how much house can you afford? If we assume that you're going to get a 6% interest rate on a 30 year fixed mortgage, we can use a multiplier of 166.79, which means that $1000 a month will be the payment on a $169,790 mortgage. However, you're going to have property taxes to pay.

Tax rates vary widely from state to state or even city to city, but 2.1% of the value of the home is close to the national average. This means that our multiplier at a 6% interest rate is now reduced from 166.79 to 129.11, meaning that $1000 a month will pay for a $129,110 mortgage.

If you already know the tax rate in your community, you can use the 169.79 multiplier to get the amount of mortgage you would qualify for, then figure the taxes and readjust until you come close. Use our monthly mortgage calculator to arrive at the final figure.

You'll also have to pay insurance. A safe number to use for home insurance is .2% of the home's value. If we use that figure, our multiplier at 6% now becomes 126.39. So, your $1000 a month will now pay for a $126,390 mortgage.

There's also the issue of a down payment. 20% has always been considered the standard down payment amount, although some lenders will go lower. FHA loans can require a down payment of as little as 3%. If you're buying a home for the first time, or don't have much equity in your existing home to use as a down payment, you'll need to find a way to get a sufficient down payment. You can't borrow the money for a down payment, but it can be gifted to you.

You can use these multipliers to arrive at a monthly payment for any income, based upon a 6% rate on a 30 year fixed.

Once you've answered the question "how much house can I afford," you need to figure out how much house you want to afford. Will that $1000 a month payment cut into your entertainment expenses, or expenses for other things that are important to you? If you need to cut expenses, are they ones that you're comfortable cutting?

The example above is just that, an example. The rate you get on a mortgage may be higher or lower than 6%. Your lender may allow more or less than 36% of your income to go towards your monthly debts.

When asking "how much house can I afford," you need to ask yourself how high a priority a house is for you. For some people it's very high, and for others it's not.