An online mortgage calculator can give you a housing payment snapshot in about 10 seconds. Quick, yes, but this method can pass over important details that leave you window shopping in a price range that’s way over your head. Here’s how to more accurately answer the "how much house can I afford" question.
Do the Math Like a Mortgage Boss
Let’s say you earn $80,000 per year and have $16,000 saved up.
First, note that you’ll need cash for closing costs in addition to the down payment. Setting aside $7,000 for closing costs leaves you with $9,000 for a down payment. We know that the lowest down payment you can make today is 3 percent, so if you divide $9,000 by 3 percent, you get a home price target of $300,000.
So far, so good! Now let’s see if your income can afford a $300,000 condo with 3 percent down. Here’s the breakdown:
Purchase price: $300,000
Down payment: $9,000
Loan amount: $291,000
30-year fixed-rate estimate: 4.25 percent
Monthly payment: $1,432
Property taxes: $300
Private mortgage insurance: $238 (required when down payment is less than 20 percent)
Condo HOA dues: $250
TOTAL MONTHLY HOUSING COST: $2,286
On top of this $2,286 housing payment, let’s say you also have car, student loan (so over it) and credit card payments that amount to $575, which brings your total monthly costs to $2,861.
If you divide $2,861 in total bills by the 43 percent back-end debt-to-income ratio (DTI) that a lender allows you to spend on bills (for conventional loans), you get $6,653, which is the amount you can spend per month on housing. This equates to just under $80,000 per year, so you’re good to go!
Remember, 43 percent debt-to-income ratio is used to calculate MAX affordability, the max amount of money you may qualify to borrow. If you want to buy less home to save more — or if your results from these calculations put the income above what you earn — lower the purchase price.
What About Tax Benefits of Homeownership?
The numbers above represent your monthly payments. However, you save money when you file taxes each year because you get to deduct mortgage interest and property taxes. Wait. What?
Let’s calculate these tax benefits on your $300,000 purchase price with 3 percent down.
A full year of mortgage interest and property taxes would be about $12,622 and $3,600, respectively. These two deductions reduce your taxable income by about $16,222.
To quickly calculate your estimated tax savings, multiply $16,222 by your estimated tax rate of about 28 percent.
The result is $4,542, meaning you'll pay about this much less in taxes annually because of your homeowner deductions.
If you convert this to a monthly figure of $379 and subtract it from your total housing payment of $2,286, it reduces your housing cost all the way down to $1,907. That’s crazy!
To confirm these calculations based on your specific profile, talk with a tax pro.