How Much House Can I Afford

Here's how to calculate how much house you can afford

Ryan Pineda

November 18, 2021

With real estate prices rising so fast many people are left wondering how much house can they actually afford. I'm going to answer that question for you as well as give you my top secret for determining what kind of loan you should get. Let's talk about how much house you can actually afford. I'm going to assume that you're getting a loan to buy your house. Assuming you're getting a loan, the first thing you think about is your credit score. If you're like most people, you probably think you've got to have a really good score in order to qualify for a loan. That's actually false.

Right now you could go get a mortgage on a house with a 620 credit score and still get an extremely low interest rate. I'm talking about a sub 3% interest rate. Having an 800 score isn't going to magically give you a 1% interest rate. It's really not that big of a difference at the end of the day. So don't worry too much about your credit score when it comes to getting a mortgage. The biggest thing that you're going to have to worry about is your debt to income ratio, also known as your DTI.  So let's talk about how we determine this debt to income ratio.

So the first part to determine is your income. Now, the way that you're going to figure that out is by taking your last two years tax returns. So let's just say in 2019, you made \$50,000. Then you made more money. So let's call it \$70,000. Now, what they're going to do is take the average of these two numbers. So \$50,000 plus \$70,000 gives us \$120,000. They're going to divide that by two and equals \$60,000. So they're going to say your income is \$60,000. It doesn't really matter to them that you're making more in 2020, and you'll probably make more in 2021. They have to take the previous two years of history. It doesn't stop there. We need to take the \$60K and make it monthly. So we'll divide it by 12 and it ends up being \$5K a month.

So that's the first step of figuring out your debt to income ratio, how much the income actually is per month. Now there is one thing you need to be aware of with these two year's tax returns. You need to be in the same job or the same type of career. If you made this \$50K as a truck driver in 2019, and then you made this \$70K as a real estate investor in 2020, they're not going to take that. They are two totally different jobs in that scenario. They would want to see you go to 2021 and see how much you made as a real estate investor then. So you may not even qualify for a loan if these are two different careers in two different years.

Now for your debts, they're going to take everything you owe as a monthly payment. So this would include your car, student loans, your credit card, and then lastly your mortgage, and then any miscellaneous debts that I'm not thinking of. If you've got a monthly payment that's on your credit report, this is going to be included as a part of your debt. You have to calculate what the minimum monthly payment is. Let's just do a quick example. Let's just say that your car payment is \$300. Say you got another \$400 in student loans, you got \$300 in credit card payments. It gives you a grand total of a thousand bucks before you account for your mortgage.

In order for us to solve for how much your mortgage payment can be, we must first determine what an acceptable ratio is. So the acceptable DTI to get alone is usually around 40% to 50%. So from our previous example, we had a monthly income of \$5,000 that was after the two years tax returns. Then we also have a debt of a thousand dollars including the car payment, the student loans, it also included credit card payments.

The only thing we don't know is the mortgage, but now we also know that the debt to income ratio can only be 50%. So half a \$5,000 equals \$2,500. So now this \$2,500 is the maximum amount of debt we are able to have. We already have a thousand dollars in debt payments every month, that means our mortgage can only be an extra \$1,500.

Now you might be wondering how much house does \$1,500 get you? Well, that'll vary depending on how much down payment you put, what kind of interest rate you get a high, and how high your property taxes are, what kind of HOA you have. All of those factors have to be included in this \$1500. HOA is a big one that I see people not take into account. They think that their mortgage is \$1500, so they're good, but then they have a hundred dollar HOA and it puts their DTI too high. So don't make the mistake of not calculating the HOA, the taxes and the insurance. \$1,500 represents a loan of about \$280,000. Now that doesn't mean that the house you're buying is \$280,000. You could be buying a \$300,000 house and putting 20 grand down where you could be buying a \$400,000 house and putting \$120,000 down. So this is just strictly based on the loan amount.

Speaking of loans, let's transition and talk about what kind of loan you should get and some secret hacks you can do to make sure you qualify. So let me give you a quick tax secret when it comes to qualifying for your loans. Many of you already know, but I own a CPA company called TrueBooks and we help real estate investors all across the country, save money on their taxes. Usually our goal is to write off as much as possible and figure out how to get you all the tax deductions you deserve. There is one scenario where it's not the best thing to do. That is, if you're trying to buy a home and you need to qualify for a certain amount. Let's just say you needed your income to be \$100,000 to qualify for the loan that you want to get.

Let's just say you've made over a hundred thousand dollars, but by the time you write everything off, you're only showing \$60,000 in income. Well, if you write all those things off, you are now not going to qualify for the house you want. So my advice to you is do not take every write-off. The last piece you've got to decide is what kind of loan to get now for most people, they're going to be deciding between FHA and conventional. If you have a military background, you can qualify for a VA loan as well. Personally, I always believe in putting the minimum down payment. So for conventional that would be 3%, for FHA that would be 3.5%.

Now, if you listen to Dave Ramsey and all these other people, they'll tell you that you need to put 20% down, stop. Putting 20% down allows you to get rid of your mortgage insurance. It allows you to have a lower payment. There are benefits to it, but for most people saving up 20% would take them far too long. I would rather them get into a house today with less.

My opinion is this. If you can't qualify for the house you want with a minimum down payment, either you want too big of a house or you need to figure out how to make more money. That's pretty much what it comes down to unless you're getting a jumbo loan. Unless you're getting a jumbo loan, stick with the low down payment. I would much rather you do 3% or 3.5% than worry about doing a bigger one.