How to Calculate How Much House I Can Actually Afford

First time homebuyers, and even experienced homebuyers who may be buying in a new area or buying into a higher price point, often ask me how much house they can really afford or how much of their income their mortgage should be. The key to answering these questions is understanding that the total cost of homeownership includes a lot more than just your monthly mortgage payment. To answer it, let's take a look at how to calculate how much house I can afford.

How Much House Can I Really Afford?

When most people try to calculate how much house I can afford, they fall short because they only look at the monthly mortgage payment. Every home listing site, mortgage broker, lender and even Google has a basic mortgage calculator you can plug in your home purchase price, down payment, interest rate and mortgage period, and it will spit out your monthly mortgage payment.

Calculating Your Monthly Mortgage

You may look at that number, compare it to your current monthly rent, and say, "I can afford that!" The problem, however, is that your mortgage payment is only a part of the total cost of homeownership.

Every month, when you just write one check for rent, your landlord pays their mortgage, home insurance, property taxes, and for any maintenance issues that arise as well. Some rentals even include utilities in the monthly rent. If you're the homeowner, you will have to pay for all those costs too. If you fail to account for them when buying your home, you can end up buying more house than you can afford and house poor.

Breaking Down the Total Cost of Ownership

If you have never owned a home before, you may not be aware of all the additional costs of homeownership beyond your monthly mortgage. And even if you know what they may be, you may not be sure how to estimate those costs.

Let's walk through each of the additional costs you may incur as a homeowner, rules of thumb for estimating them and resources for determining your incremental costs.

Private Mortgage Insurance

Up first, PMI. You may have heard of PMI, but not know exactly what it stands for or how it works. For many traditional mortgages, you will have to put down at least 20% of the purchase price as a down payment, while taking out a mortgage for the remaining 80%.

If you don't have a down payment of at least 20%, you will have to pay for PMI, or private mortgage insurance. As the name implies, this is the premium for an insurance policy that you pay for on your lender's behalf. Putting less than 20% down on your home makes you a higher credit risk. Lenders alleviate this risk by requiring you to take out mortgage insurance so that if you fail to pay your mortgage, the insurance policy pays it off for them.

PMI isn't cheap. It typically costs between 0.5 and 1.0% of the value of your mortgage annually. And you will have to pay it until your mortgage is less than 80% of the value of your home, at a minimum, and some lenders have more stringent requirements for eliminating this additional monthly cost.

Even once you have paid down your mortgage or your home has increased in value to lower the loan-to-value ratio, you will have to pay for an appraisal before PMI is eliminated, and in some cases, you may still be stuck with PMI for a minimum period of time per your mortgage agreement.

Property Taxes

Property taxes are set at the local level, and can vary significantly from town to town, and even more dramatically from state to state. They range nationally from 0.3% to as much as 2.5% of the value of your home annually. Want to see what property taxes are in your state? Check out this list of property taxes by state here. Remember: rates vary locally, but this will give you some indication of what the rate will be in your area.

When reviewing listings before buying a home, the historical property taxes are disclosed as well, and you can use this as a good estimate for what your future taxes will be. If you are buying a new home, ask your realtor what the local property tax rate is and apply it to the appraised value of your home.

Property Insurance

If you take out a mortgage to buy your home, you are required to have property insurance to insure the value of the home. And even if you own your home outright, property insurance is always a good idea to protect the value of what is for most families their largest asset.

Related Post: What Every Mom Should Know About Property Insurance

Property insurance premiums are another annual cost that can vary dramatically by state and geography. Premiums are depending on the value of the asset being insured, the liability coverage you add to the policy (this protects you if you are ever sued), and the general risks in your area. Oklahoma has the most expensive property insurance in the country due to tornados, and homes by the water often carry higher premiums as well, and may even require separate coverage for flood and hurricanes.

You will be required to provide proof of insurance at your mortgage closing, so it is a good idea to reach out to and work with an insurance broker to get the necessary coverage you need for your home, at a premium, annual deductible and level of liability coverage you are comfortable with.

The table below, based on property insurance data from Insurance.com, shows the average annual premium for a $300,000 home, with $300,000 liability coverage, and a $1,000 annual deductible. If you have not yet been quoted on a policy, you can reference the premium cost in the table below to when determining how to calculate how much house I can afford.

HOA Fees

Make sure you understand if you are buying a home that is part of a Home Owner's Association. While an HOA can provide many services and amenities, it also comes at an additional monthly cost. These can range from as low as $100 to more than $700 every month, depending on the size of your community and exactly services and amenities are included.

It is also important to understand the financial health of your HOA, and you should review their documents and financial statements prior to closing. If poorly managed, HOA's can assess homeowners for additional payments to meet budget gaps or to complete large capital projects in the neighborhood.

Not all homes are part of an HOA, and many may not have these fees.

Home Maintenance

One last major contributor to how much house you can afford is home maintenance costs. This is often an area many first time home buyers underestimate if they remember to include it at all. A good rule of thumb? Estimate home maintenance costs of 1-2% of the value of your home annually, or $1-2/square foot.

Home Maintenance Rule of Thumb: 1-2% of the value of your home each year

You may buy a brand new home, in which the home maintenance costs are less, but having lived in two brand new homes, I can assure you they will still not be zero. If you buy an older home, your home maintenance costs will likely be on the higher end of this rule. These costs can include everything from major repairs and replacing appliances, to costs like snow removal and lawn services.

Set up a sinking fund to set money aside every month for home maintenance. There will be years where you may spend far less... but there will also be years where you have to replace your dishwasher, the roof and remove a dead tree all in the same year.

How to Calculate How Much House I Can Afford

Now, armed with insights into all the potential incremental costs of homeownership, now try to calculate how much house you can really afford.

How much more is your total monthy cost of home ownership than just your mortgage payment? Many first time home buyers are shocked when this total is as much as double just their monthly mortgage payment. This is why it is so important to not over-extend yourself on your mortgage... because the total cost is so much more, and an important part of answering the question: how to calculate how much house I can afford.

One last thing... Don't Forget Utilities!

Some of you may be lucky enough to have even utilities covered in your monthly rent. This isn't the case for everyone, so I didn't include it in the total cost analysis above... but know that if you don't have an electric, gas and water bill now, you will when you own a home.

Similarly, if you are moving from a 1,200 square foot apartment or townhome with shared walls that help insulate you from cold in the winter and heat in the summer, your utilities will be more expensive in a standalone, larger house. Or maybe you are moving from an electric heater to a propane or natural gas one and are unsure of what to expect for cost.

How to get a handle on these? Ask the sellers for their utility history. Realtors are also used to handling questions like these and will be happy to get this information for you.

Make sure you also confer with your realtor to understand what services are included in your town for your property taxes. While some municipalities include things like sewer and garbage pick-up, others do not. You may have to contract for private services (at additional cost) or drive your trash to the dump weekly yourself.

So, ready to buy a new house?

If you're ready and wondering if now is a good time to buy, be sure to check out this post on the factors to evaluate in the current housing marke to decide if this is a good time to buy a house.

So, ready to buy your next house? What other questions do you have about mortgages and home ownership? Leave them in the comments, or ask me live every weekday at 10AM ET on Instagram.

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