How Much House Can I Afford to Buy?

For most people, buying a home will be the biggest purchase of your life – so you want to make sure you get it right.

You've got to consider the kind of property you want, the location, schools, commute, and all those other lifestyle factors. Most importantly, you have to think carefully about your budget and how much house you can afford.

The house price is only one factor that goes into determining your monthly mortgage payment. It's made up of several different parts and you'll need to understand them all before you can figure out what house you can afford.

What's Included in My Monthly Mortgage Payment?

You might think your mortgage equals the price of your home divided by the number of months it will take you to pay it off. If only it were so simple! The reality is that your monthly payments will mostly go toward interest for the first few years of your loan.

The parts that make up a typical mortgage are called PITI. Find out what that means below.

P = The Principal

This is the main part of your loan, equal to the price of your house less any down payment. So if your house costs $400,000 and you have $100,000 cash to put down, you'll have a principal loan of roughly $300,000.

But don't forget all the fees that go into buying a house. Often a chunk of your $100,000 will be eaten up by closing costs, inspection fees, and other expenses. So your principal loan will end up being a bit more unless you have money for those costs set aside.

I = Interest

When you get your home loan, interest is something you'll want to keep in mind. You may choose a fixed-rate mortgage or an adjustable-rate mortgage (ARM). Either way, an ARM tends to come with a fixed rate for an initial period.

Let's say you agree to a mortgage with 4% interest on your $300,000 principal loan. That could work out as about $215,000 in interest over the life of a 30-year loan.

A process called amortization means your interest payments are spread out over time, which is why your payments will go more on interest at the beginning of your loan and more on the principal towards the end.

T = Taxes

Tax generally refers to the property taxes you'll pay to your city or municipal government. These taxes can vary significantly between different states and towns so be sure to check what typical rates are in your area before you start looking for your dream home.

For example, property taxes of $3,000/year may add $250 to your monthly mortgage payment, while taxes of $12,000 may add a full $1,000. Keep in mind, you may pay a chunk of taxes upfront or in advance, which means they'll have less effect on your monthly payment.

Also, be sure to see how your local government is spending your property taxes. Sometimes the money goes toward public schools. Other times it might be eaten up by municipal debt.

I = Insurance

Mortgage lenders will usually require you to have home insurance as a condition of giving you the loan. Insurance will typically cover damage to the outside of your house caused by a disaster or accident, as well as damage to your house contents, or theft of your property.

Be sure to check exactly what is and isn't covered in your area. For example, you may need additional flood or fire insurance or separate insurance for high-priced possessions. Insurance will typically add between $100 and $150 to your monthly payment.

Factors That Affect Your Mortgage

Two additional factors will have a huge impact on your monthly mortgage payment. These should be considered when deciding how much house you can afford.

Down Payment

Your mortgage lender will likely require a down payment, or cash that you have set aside to go toward buying your house.

A common down payment is about 20% but it could be as low as 1% of the house price. The more money you can put down upfront, the less your principal loan.

For example, if you've saved up $80,000 towards your $400,000 house, that could equal a down payment of 20%. Your principal loan would then be $320,000.

Just don't forget all those closing costs, which you'll need to have on hand or they'll be deducted from your down payment.

Loan Terms

The term of your mortgage is how long you're planning to take to pay the loan back. Terms for a fixed-rate mortgage are usually between 10 and 30 years, with 30 years being the most common. You can discuss different terms and variable interest rates with your lender.

Think carefully about your term because a $300,000 loan paid back over 15 years might mean payments of about $2,200/month, compared to just $1,400/month for a 30-year term. On the other hand, a 30-year term will mean you pay a lot more interest over the life of the loan.

Understanding the 28/36 Rule

The 28/36 rule is a quick and simple way for lenders to figure out if you're going to be a safe bet for a mortgage.

The rule suggests:

• You should spend no more than 28% of your gross income on your total mortgage (PITI), plus any condo or homeowner's association (HOA) fees.

• You should spend no more than 36% of your gross income on your mortgage and HOA plus your other debt (credit cards, auto loans, etc.) if it's expected to take over 12 months to repay it, as well as any alimony or child support payments.

Your lender will likely add up your household's total debt and compare it to your household's total gross income to figure out your maximum monthly mortgage payment.

So How Much Mortgage Can I Afford?

Buying a house is complicated but experts are always on hand to make the process easier for you, and even enjoyable.

Listerhill is here to help you every step of the way. In the market for a new home? Find out how much house you can afford today!

Check out our Mortgage Affordability Calculator and other mortgage calculators to get started today.