How Much House Can I Afford?
There are two House Affordability Calculators that can be used to estimate the affordable amount for houses based on either household income-to-debt estimates or fixed monthly budgets. They are intended for use by residents in the United States only.
House Affordability Based on Fixed, Monthly Budgets
This is a separate calculator used to estimate house affordability based on monthly allocations of fixed amounts for housing costs.
Conventional, FHA, and some other mortgage lenders like to use two ratios called the front-end and back-end ratios to determine the home loans that each household can afford. They are basic debt-to-income ratios, albeit slightly different. However, all potential homeowners should take steps toward achieving more desirable ratios in the eyes of lenders if they seek houses out of their affordability range.
Front-end debt ratio is also known as the mortgage-to-income ratio, computed by dividing total monthly housing costs by monthly gross income. For our calculator, only conventional and FHA loans utilize it. The monthly housing costs not only includes interest and principal on the loan, but other costs associated with housing like insurance, property taxes, and HOA/Co-Op Fee.
Back-end debt ratio is the more all-encompassing picture of a household’s ability to serve home loans. It includes everything in the front-end ratio dealing with housing costs, along with any accrued recurring monthly debt like car loans, student loans, and credit cards. This ratio is commonly defined as the well-known debt-to-income ratio, and is used for all the calculations.
Conventional Loans and the 28/36 Rule
In the US, a conventional loan is a mortgage that is not insured by the federal government directly and generally refers to a mortgage loan that follows the guidelines of government-sponsored enterprises (GSE’s) like Fannie Mae or Freddie Mac. Conventional loans may be either conforming or non-conforming. Conforming loans are bought by housing agencies such as Freddie Mac and Fannie Mae and follow their terms and conditions. Non-conforming loans are any loans not bought by these housing agencies and don’t follow their respective terms and conditions, but are generally still considered conventional loans.
The 28/36 Rule is a commonly accepted guideline used in the US and Canada to determine each household’s risk for conventional loans. It states that a household should spend no more than 28% of its gross monthly income on the front end and no more than 36% of its gross monthly income on the back end. The 28/36 Rule is a qualification requirement for conforming conventional loans, required by Fannie Mae or Freddie Mac guidelines.
While it has been adopted as one of the most widely-used methods of determining the risk associated with a borrower, as Shiller documents in his critically-acclaimed book Irrational Exuberance, the 28/36 Rule is often dismissed by lenders under heavy stress in competitive lending markets. Because it is so leniently enforced, more often used as a general rule of thumb, lenders find ways to work around it, usually with risky borrowers who wouldn’t have initially qualified under it.
Quick Tip: As a borrower in the marketplace searching for mortgages, it can be tempting to accept enticing offers from anxious lenders trying to meet management numbers. Don’t make this mistake, as a financial mishap of this magnitude can leave borrowers in pieces if things don’t go as planned.
Please visit our FHA Loan Calculator to get more in-depth information regarding FHA loans, or to calculate estimated monthly payments on FHA loans.
An FHA loan is a mortgage insured by the Federal Housing Administration. Borrowers must pay for mortgage insurance in order to protect lenders from losses in instances of defaults on loans. The insurance allows lenders to offer FHA loans at lower interest rates than usual with more flexible requirements, such as down payment as a percentage of the purchase price.
To be approved for FHA loans, the front-end and back-end ratios of applicants need to be better than 31/43, respectively. In other words, monthly housing costs should not exceed 31% and all secured and non-secured monthly recurring debts should not exceed 43% of monthly gross income. FHA loans also require 1.75% upfront premiums.
It is immediately apparent that FHA loans have more lax debt-to-income controls than conventional loans; they allow borrowers to have 3% more front-end debt and 7% more back-end debt, and thus cater to riskier borrowers. Payments of mortgage insurance premiums by borrowers are what allows FHA to take on more risk.
Please visit our VA Mortgage Calculator to get more in-depth information regarding VA loans, or to calculate estimated monthly payments on VA mortgages.
A VA loan is a mortgage loan granted to veterans, service members on active duty, members of national guards, reservists, or surviving spouses guaranteed by the U.S. Department of Veterans Affairs (VA).
To be approved for VA loans, the back-end ratio of applicants need to be better than 41%. In other words, the sum of monthly housing costs and all recurring secured and non-secured debts should not exceed 41% of monthly gross income. VA loans generally do not consider front-end ratios of applicants but require funding fees.
For our calculator, we assume all VA loans are first-time use.
Custom Debt-to-Income Ratio Percentages
Aside from conventional, FHA, and VA loan ratios, there are also options to choose from a list of custom numbers from 10% to 50%. The numbers represent their debt-to-income ratios expressed as percentages. If coupled with down payments less than 20%, 0.5% of PMI insurance will automatically be added to monthly housing costs because they are assumed to be calculations for conventional loans. There are no options above 50% because that is the point at which DTI exceeds risk thresholds for nearly all mortgage lenders.
Quick Tip: Use lower percentages for more conservative estimates. A 20% DTI is easier to pay off during stressed financial periods compared to, say, a 45% DTI. The Conventional Loan option, which uses the 28/36 Rule, is one method that can be used when unsure.
Some people will use the calculator to learn that they cannot afford their dream home. There are steps that can be taken to increase house affordability, albeit with time and due diligence.
- Reduce debt in other areas This may include the choice of a less expensive car payment or paying off all student loans. In essence, lower standards of living in other areas in order to afford a highly sought-after house.
- Increase credit scores A better credit scores can help the buyers to find a loan with better interest rate. A lower interest rate helps the buyer’s affordability.
- Bigger down payments Paying more upfront accomplishes two things. One, it directly increases the amount the buyer can afford. Two, a big down payment help finding a better interest rate and therefore increase the buyer’s affordability.
- Save more When DTI ratios aren’t satisfied, mortgage lenders may look at amounts of savings of borrowers as compensating factors.
- Higher incomes Although much harder to accomplish than the others, it can culminate in the most drastic change in a borrower’s ability to purchase a certain home. 25% to 50% increase in salaries are not out-of-the-norm for the people who deserve it, and such jumps immediately have large impacts on DTI ratios. It is easier said than done though. It usually involves differing combinations of higher education, improving skills, networking, constant job searching, and lots of hard work.
Working towards achieving many or even all of these things will increase a household’s success rate in qualifying for purchases of homes in accordance with real lenders’ standards of qualifications. If these prove to be difficult, maybe consider less expensive homes. Some people find better luck moving to different cities. If not, there are various housing assistance programs at the local level, though these are geared more towards low-income households. Renting is a viable alternative, despite what conventional wisdom peddles; it may be helpful to rent for the time being in order to set up a better buying situation. Use our Rent Calculator to determine an affordable monthly rent based on income and debts.