How Much Home Actually Fits Your Budget?

When you get pre-approved for a mortgage, it’s exciting. The number your lender gives you can feel like permission to go out and find a house that maxes out that amount. 

However, it’s important to take a pause. What a lender says you can borrow and what you should borrow are different numbers. While the loan preapproval is important, to build a realistic homebuying budget you need to take into account the full picture of your financial life.

So before you fall head over heels with a listing, you first need to determine how much house actually fits your life, not just your debt-to-income ratio.

The Lender’s Number vs. Your Number

When you go to a mortgage lender for a loan, they evaluate your finances through a standard set of metrics. They look at your credit score, your income, your current debts, and your assets. With these inputs, they calculate your debt-to-income ratio (DTI), which is the percentage of your gross monthly income that goes toward debt payments. And then, with your DTI as the primary factor, they decide how much they’re willing to lend to you. 

When it comes to the optimal DTI, most traditional lenders prefer a maximum ratio of 43% or lower, though some may go higher depending on other factors. However, just because a lender is willing to offer you a loan up to a certain purchase price of a home, that doesn’t mean you should take the full amount. 

This is where the 28/36 rule comes in handy. 

This classic personal finance guidance advises that your monthly mortgage payment should not exceed 28% of your gross monthly income, and your total debt payments (including your mortgage) should not exceed 36%. While it’s not a hard and fast rule, it’s a useful rule of thumb to help you figure out what percentage of income should go to mortgage payments without making you feel house poor.

The Real Cost of Homeownership

While the monthly mortgage payment may be the primary expense associated with your new home, many first-time buyers make the mistake of treating it as the only number that matters. In reality, there are many other expenses to consider when purchasing a home.

Down Payment and PMI

Your homebuying budget isn’t limited to just monthly payments. As most first-time buyers know, saving for a down payment is the first hurdle to overcome. If you put down less than 20%, expect a higher interest rate and private mortgage insurance (PMI), which is an additional cost that protects the lender in case you default. PMI typically runs between 0.5% and 1.5% of the total loan amount on an annual basis. 

Closing Costs

On top of that, your down payment and closing costs can run 2% to 5% of the loan amount. These include things like origination fees, title insurance, and prepaid taxes. For a $350,000 home, that could range from $7,000 to $17,500 due at closing.

Property Taxes and Homeowners Insurance

In addition to upfront costs, property taxes and homeowners insurance can contribute significantly to how much you pay monthly for your new house. These expenses are typically rolled into your monthly payment through an escrow account, making them easy to overlook, but they are very real costs. Depending on where you decide to buy, these can often add $300 to $700 or more to what you owe each month.

HOA Fees

If the property is part of a homeowners association, HOA fees are another line item in your budget. These fees can vary widely — from $10 a month to several hundred in others — but they’re usually non-negotiable once you own the home.

Maintenance and Upkeep

Finally, you can’t forget maintenance. It’s a good rule of thumb to budget 1% of the value of the home per year for upkeep and repairs. For example, if your home is worth $350,000, then you’d need to set aside $3,500 annually (about $292 each month) to have a fund for addressing things like a leaky roof, an old HVAC system, or a new water heater when the old one gives out.

Don’t Forget Life’s Other Expenses

When in homebuying mode, it’s easy to get excited about a listing and rationalize the monthly payment. But don’t forget, your homebuying budget must coexist with the rest of your financial responsibilities. That means being brutally honest with yourself about what you’re working with. 

Before you commit to a monthly mortgage payment, carefully review the following:

• Monthly bills: Calculate your expenditures on anticipated utilities and existing car payments, student loans, and credit cards.
• Savings goals: Will you be able to keep up with retirement contributions, maintain an emergency fund, and save up for future large purchases?
• Lifestyle spending: If you enjoy dining out, travel, hobbies, and other fun things, make sure those can still fit into your monthly budget with the new mortgage payment.
• Childcare and education costs: If you have small children or are paying for tuition, factor that in, too.

If the proposed mortgage payment would require you to stop retirement contributions or drain your savings to zero every month, then it’s likely too high. Even if the lender says you qualify, that doesn’t mean it’s the best decision for your financial future.

Build a Homebuying Budget that Works for You

Amplify Mortgage Loan Originator Shalinee Bhardwaj puts it simply: “The goal isn’t to get into the biggest house possible. It’s to get into the right house for you, and to still be able to live your life.” That means thinking through what monthly payment you’re genuinely comfortable with, and not just the maximum you qualify for. 

To arrive at that number, let’s put it all together:

1. Start with your gross monthly income and apply the 28/36 rule as a benchmark.
2. Subtract estimated property taxes and homeowners insurance, and any anticipated HOA fees from your target payment to determine your true mortgage ceiling.
3. Factor in PMI if your down payment is less than 20%
4. Account for closing costs. Make sure you have enough cash left over after closing, not a zero balance.
5. Run the remaining payment against your full monthly budget, including savings goals and lifestyle costs.
6. Use a home affordability calculator to stress test different scenarios.

The end goal is to arrive at a number that you can afford to spend comfortably every month, not just theoretically. The house you can afford on paper is not necessarily the house you can afford in practice. Knowing the difference will allow you to enjoy your new home and other areas of your life.

The Bottom Line

Lenders are there to tell you how much you can borrow. But it’s up to you to determine how much you should. By taking a look at the full cost of purchasing a home, including the monthly mortgage payment, closing costs, maintenance, HOA fees, and your ongoing monthly expenses, you can create a homebuying budget that gives you room to breathe, save, and enjoy the home you worked so hard to buy.