Whether you’re in the market for your first home or you’re looking for a bigger house that can accommodate a growing family, the decision to buy a house is an exciting one, and one that deserves to be celebrated!
Before you accidentally fall in love with a house outside your budget, it’s a good idea to crunch the numbers so that you have a clear sense of what you can realistically afford to buy. You want to ask yourself these questions: how much house can I afford? How much mortgage can I afford? This article walks you through exactly how to get the answers to these essential questions so you can confidently buy your dream home.
Below, we take a look at the average cost of a mortgage with today’s interest rates. We also discuss other factors that will affect your total monthly housing cost, and offer guidance that you can use to make homeownership more affordable.
Factors That Affect Mortgage Affordability
Before you apply for a mortgage, it’s important to have a clear understanding of the different factors that influence the cost of your loan. While there are many potential factors to consider here, the most important tend to be:
Your Home’s Price
Your mortgage is the amount of money that you need to borrow in order to purchase your home. It makes sense, then, that the more expensive your home, the more you’ll have to borrow—and the more you’ll ultimately have to pay back, both in the form of principal and interest.
Your Down Payment
Your down payment is the amount of money that you pay out of pocket when you purchase your home. Generally speaking, making a larger down payment will translate into lower interest payments over the life of your mortgage, because it lowers how much money you ultimately need to borrow.
Most financial experts recommend that borrowers put at least 20% down when buying a home. That being said, there’s nothing stopping you from making a larger down payment if you wish, especially if you are looking for ways to lower your mortgage costs.
Your Interest Rate
Interest is the fee you pay in order to borrow money. When you repay a debt, like a mortgage, you aren’t just repaying the amount that you originally borrowed; you’re also making interest payments on top of that principal. With this in mind, the higher your interest rate, the more expensive your mortgage will be; the lower your interest rate, the less expensive your mortgage will be.
A lot of factors go into determining your interest rate. Some of them—such as your credit score—are within your control. But some of them—such as current mortgage rates—are out of your control.
Different lenders offer different mortgage rates, so it’s worth it to shop around to make sure you get the lowest possible interest rate that you qualify for. Shaving even .25% off of your interest rate can translate into tens of thousands of dollars in savings over the life of your mortgage.
Your Mortgage Term
A mortgage’s term is simply a measure of how long it will take for you to repay the loan, interest included. While most mortgages today carry a 30-year term, other terms are also available, including 15-year and 10-year terms.
Generally speaking, the longer your term, the higher your interest rate will be, but because you have a longer period to pay off your loan, your payment is still lower with a longer term compared to a shorter term.
How much does the typical mortgage cost at today’s interest rates?
According to Bankrate, the average 30-year fixed rate mortgage currently carries an interest rate of 7.32% (as of November 9, 2022). Knowing this, let’s run through a quick example to see how much the typical mortgage costs at today’s interest rates.
For this example, let’s assume a home price of $500,000 and a 20% down payment, resulting in a $400,000 30-year fixed rate mortgage.
With all of these factors accounted for, we arrive at a monthly mortgage payment of $2,748. Repaying the loan will take a total of $989,180 over 30 years. Approximately $589,180 of that total will be in the form of interest payments.
As an important note, this does not include any of the other costs commonly associated with homeownership, such as property taxes, homeowners insurance and HOA fees.
Other Costs Of Homeownership
Your mortgage payment is likely to be the biggest monthly cost associated with owning a home, but it’s not the only cost that you should be aware of. Other common costs that you need to consider as you budget to buy a home include:
Property taxes: State and local governments collect property taxes from homeowners in order to pay for critical services and infrastructure. How much you pay in property taxes will depend on where you live. According to Rocket Mortgage, property taxes range from a low of 0.28% of a home’s appraised value in Hawaii to a high of 2.49% in New Jersey. Usually, property taxes are due every six months.
Homeowners insurance: Homeowners insurance is designed to help you pay for unexpected damage or destruction that hits your home. While there’s no law legally requiring you to carry homeowners insurance, coverage is required by mortgage lenders as a term of your loan. According to Bankrate, the average homeowners insurance policy costs $1,383 per year, or about $115 per month.
HOA fees/Co-Op fees: Depending on where you live, you may find yourself on the hook for homeowners association (HOA) or co-op fees. These fees are used to cover the cost of maintaining common areas shared by the community. Fees can range from $100 to $1,000 or more per month, though the average currently sits at approximately $170 per month.
Maintenance: As a homeowner, you’ll also be required to cover any required maintenance on your home. This will include everyday maintenance (such as plumbing or electrical repairs) as well as more significant maintenance (such as replacing a roof). While it can be difficult to know precisely how much you’ll spend each year on maintenance costs, many financial professionals recommend that you budget approximately $1 per square foot per year on basic maintenance. Another common rule of thumb is to expect to spend 1% of your home’s value on maintenance each year.
If you set up an escrow account as part of your mortgage, your monthly payment will include some of these expenses. For example, escrow payments often include the cost of your homeowners insurance premiums as well as your property taxes.
How much of your monthly income should you spend on mortgage payments?
The 28% rule is a common rule of thumb that states that you should apply no more than 28% of your gross monthly income (your income before taxes and deductions) toward mortgage costs. This includes everything that you pay toward principal, interest, taxes, and insurance (PITI).
Another rule, known as the 28/36 rule, builds upon the 28% rule. Under the 28/36 rule, no more than 28% of your gross monthly income should be dedicated toward mortgage expenses, and no more than 36% of your gross monthly income should be dedicated to total debt servicing. This total includes your mortgage expenses as well as other debt repayment such as credit cards, auto loans, and student loans.
Here at Monarch Money, we generally recommend a slightly more conservative approach of limiting your total monthly debt payments (including mortgage and non-mortgage debts) to no more than 30% of your gross monthly income. That’s because lower debt payments make it easier to pay for your other living expenses and still find dollars for your longer term financial goals like saving for retirement. Calculate how much you need to earn to afford a home using our mortgage calculator.
Budgeting for Your Mortgage
If you were to follow the 30% rule outlined above, it then becomes fairly easy to budget for your eventual mortgage payment and determine how much mortgage you can afford. When budgeting with a partner create a joint view of your income and spending to make sure you have a shared understanding of your household finances. All you need to do is:
Determine your gross monthly income. This is your pay before taxes or deductions like health insurance or retirement contributions.
Find 30% of this amount by multiplying it by 0.30.
Add together all of your non-mortgage related debts. This should include credit card debt, car loans, student loans, personal loans, etc.
Subtract the amount found in Step 3 from the amount found in Step 2.
The amount that remains is the maximum amount of money that you should consider for a monthly mortgage payment (including homeowners insurance, property taxes, and HOA/co-op fees).
For example, imagine that your gross monthly income is $10,000. Each month, you pay $200 to service your credit card debt, $300 on your car loan, and $250 on your student loans. To find out the maximum monthly mortgage payment you should consider, all you need to do is:
Find 30% of your gross monthly income: $10,000 x 0.30 = $3,000
Add up all of your non-monthly mortgage debts: $200 + $300 + $250 = $750
Subtract the second number from the first number: $3,000 - $750 = $2,250
In this example, $2,250 is the maximum monthly mortgage payment that you should consider, given your income and non-mortgage debts.
Tips to Make Your Mortgage More Affordable
Looking for ways to make your mortgage more affordable? Here are some tips that can help lower or offset the costs of borrowing for your home.
Lower your interest rate
If you can lower the interest rate on your mortgage by even 0.25%, you could save tens of thousands of dollars in savings over the life of your loan. The question is: How might you qualify for a lower interest rate?
One of the easiest ways to do this is to shop around by comparing offers from different lenders. While you could do this manually by inquiring with multiple different lenders, there are also a number of online platforms that make it really easy to compare rates and settle on the best offer.
Another option, especially if you aren’t in a rush to buy a house, is to take steps to improve your credit score. The higher your credit score, the lower the rate you may ultimately be offered.
While there are many potential ways to improve your credit score, one of the faster ways of doing so is to lower your credit utilization rate by paying down credit card debt. Most lenders look for a utilization rate below 30%, and getting it lower—potentially below 10%—can offer a sizable boost to your credit score, depending on where you are starting.
Consider a larger down payment
Another way to lower your monthly mortgage payment is to simply start out with a smaller mortgage to begin with. An obvious way that you could achieve this is by purchasing a less expensive house. But you can also reduce the size of your mortgage by making a larger down payment.
Most financial professionals recommend that home buyers plan to put at least 20% down when purchasing their home. This allows you to start out with a sizable chunk of equity in your home, and is also typically enough to avoid the added cost of private mortgage insurance (PMI).
But that doesn’t mean that you can’t make a larger down payment, especially if you have the extra cash reserves.
One caveat? Don’t be tempted to drain your emergency fund in order to boost your down payment. Doing so could spell trouble, especially if you find your new home in need of a surprise repair (or two) after you’ve moved in.
Buy in less inflated real estate markets
Real estate markets have been hot all across the country for much of the last two years, pushing prices higher and higher as buyers have been forced to compete with each other for a limited stock of homes.
And while this has led to an increase in home prices across the board, certain real estate markets have seen less price appreciation than others. Buying a home in one of these less inflated markets can lead to real and significant savings.
Consider a property with income potential
Purchasing a house that doubles as a rental property can be an extremely effective means of making your mortgage more affordable—as long as you’re willing to put in the work of being a landlord and dealing with tenants. The key to success is to avoid lifestyle inflation and actually commit to using the income from your rental to help cover or pay down your mortgage.
If this path interests you, you could specifically look to purchase a multi-family home such as a duplex that allows you to have your own space while still renting out to a tenant. But you could just as easily convert a single-family home into a rental property as well by renting out a basement floor, granny loft, or even just a single room.
Managing Your Savings and Expenses
Regardless of where you are in your journey to becoming a homeowner, Monarch Money is here to help.
Still building a down payment? Use our budgeting tool to manage and automate your savings. Already own a home? Use our platform to manage and stay on top of the many expenses associated with homeownership, from your mortgage payment to your homeowners insurance premiums, property taxes, HOA fees, and more.