Thinking about buying a home? You’re not alone. With low interest rates and the growing availability of WFH jobs, now is a great time to think about buying a home. If you’re feeling ready to make the switch from renting to owning, the first thing to figure out is how much home you can afford. 

Without a clear budget, it’s easy to overspend and lock yourself into decades of challenging mortgage payments. When you start by figuring out how much home you can really afford, you can avoid getting distracted by homes outside your price range. 

Mortgage calculators don’t tell the whole story

Type “mortgage calculator” into Google, and you’ll find countless tools that promise to help you figure out how much house you can afford. All you need to do is enter a home price, and the program shows you an estimated monthly payment based on current interest rates. You can just take that number and compare it to your monthly income, right? Unfortunately, it’s not that simple. While these tools can provide ballpark figures for how much you should spend, they actually ignore a lot of key information.

Your mortgage is just one small part of your overall financial picture. While it’s easy to think that income is the only factor in determining how much you can spend on a home, we think it’s better to look at every part of your finances when planning out your house purchase.

For example, what sort of down payment are you thinking of? Ideally, it’s best to save up for a traditional 20% down payment, but that’s not always possible in today’s market. If you decide to put down less than 20%, you’ll probably have to pay for private mortgage insurance (PMI) and/or agree to a higher interest rate. The interest rate and PMI can increase your monthly payments significantly, especially if you are looking at a large mortgage.

How will a mortgage fit into your overall financial plan?

Income, interest rates, and PMI aren’t the only factors you should consider when thinking about your mortgage. What about other financial goals, like a college fund or retirement savings? That information is crucial when it comes to figuring out how much you can spend every month on your mortgage payment. 

Here at Everyday Money, we encourage you to calculate your mortgage limit based on more than just your income. Start by thinking about your retirement savings, and figure out the rate at which you need to save to build up the funds you need. Then, work backward to figure out your ideal mortgage payment. It’s also vital to be realistic about your living expenses. Your total take-home income should be enough to accommodate all three: monthly mortgage payment, living expenses (food, transportation, bills, etc.), and retirement savings.

Put it all together

So how do you know how much you should be saving for retirement? The answer is based on your spending. 

For example, let’s say you spend $165,000 annually on living expenses and mortgage payments: $3,800/month on your mortgage and $9,950/month on other bills and living costs. In order to fully fund your retirement, you need to save between $15,000 and $20,000 every year. 

That means your total annual take-home income would need to be $185,000 to cover everything: $45,600 (mortgage payments) + $119,400 (living expenses) + $20,000 (retirement savings). If your living expenses are higher, you’d need to save more money each year to fully fund your retirement. 

As you can see, your living expenses and retirement savings are huge pieces of your budget, so you can’t ignore them when you are calculating potential mortgage payments.

Instead of just looking at your income to figure out how much home you can afford, factor in all the relevant information. 

Take a realistic look at your monthly spending, use that to figure out how much you need to save for retirement, and then see what you have leftover in your monthly income for a mortgage payment. With this much information, you can get a clear picture of how much house you can afford. Knowing your limits can keep you from getting caught up in the frenzy of the volatile housing market. 

Make the home purchase that’s right for you

With all the news about historically low interest rates and the inevitable rise of home prices, you may feel like it’s essential to buy a house right now. But don’t let FOMO trick you into an unwise purchase. Buying a home right now may not be the best thing for your unique financial and personal circumstances, and that’s OK. 

Understanding your living expenses is a key to figuring out how much house you can afford, and a detailed budget gives you access to that information. With BudgetingBlocks™, it’s easy to visualize your monthly spending and get the data you need to figure out the best plan for mortgage payments and retirement savings.