How much home can you afford?

Buying a home is a major milestone that requires careful planning and financial preparation. For first-time homebuyers, the process can be daunting, with numerous decisions to make, paperwork to complete, and financial considerations to keep in mind.

However, with the right mindset and knowledge, you'll be ready to succeed in any market. In this guide to home buying, we'll cover everything you need to know to make the process smoother and less stressful.

📘 At a glance - key factors that affect your budget

• Down payment
• Closing costs
• Mortgage qualification
• Property taxes and insurance
• Other costs of ownership

Assessing your down payment options

Your down payment is a lump sum paid upfront when purchasing a home. The amount required will depend on the type of mortgage you choose and your lender's requirements.

Most lenders require a down payment of at least 20%, though some government-insured mortgages allow for down payments as low as 3.5%. If you’re like the majority of homebuyers that can’t afford to put 20% down, you’ll likely need to pay for private mortgage insurance (PMI). PMI is a type of insurance policy you pay for that protects your lender in the event you default on your loan. Unfortunately, it typically adds between 0.3-1.5% of the cost of your loan amount each year.

Saving for a down payment is typically the biggest challenge most homebuyers face, particularly if you're currently paying high rent or trying to pay off other debts like student loans. If you're like most buyers, and unable to access the required savings, there are programs to help. Crib Equity can up to double your down payment, helping you avoid the additional costs of PMI, afford a larger purchase and become a homeowner sooner.

Closing costs

Next, consider that you’ll need to reserve some additional cash for closing costs. Often overlooked, closing costs are the fees and expenses associated with buying a home, and they can add up quickly. These costs can include lender fees, title fees, appraisal fees, inspection fees and other costs that are paid at closing. Closing costs typically range from 2-5% of the purchase price of the home, but they can vary depending on where you live and the purchase price. Because these costs are paid upfront, it's important to factor them into your down payment budget to ensure that you can afford a purchase.

Qualifying for a mortgage (and loan limits)

The next step is to understand the different types of loans available, what kind of loan values you qualify for and then choosing the one that best fits your needs. The amount you can borrow will depend on your income and credit score, among other factors. For example, a borrower with a credit score of 760 could have an interest rate .50% lower than a borrower with a 680 score. For that reason, it's important to check your credit score regularly, correct any errors, and make efforts to improve your credit. It's also important to compare interest rates and fees from different lenders to get the best deal.

One way to calculate your maximum mortgage payment is to use a mortgage affordability calculator. These calculators take into account your income, monthly debt payments, and other expenses to determine how much you can afford to spend on a mortgage payment each month.

You can also use the 28/36 rule. This rule states that your monthly mortgage payment (including property taxes and homeowners' insurance) should not be more than 28% of your gross monthly income, and your total monthly debt payments (including your mortgage, credit card payments, student loans, and other debts) should not be more than 36% of your gross monthly income.

For example, if you have a gross monthly income of $5,000, your maximum mortgage payment according to the 28/36 rule would be $1,400 (28% of $5,000) and your total monthly debt payments would be $1,800 (36% of $5,000).

When applying for a mortgage, lenders will consider your income, monthly debt payments, and other factors to determine how much you can borrow and what your monthly mortgage payment will be. Combining the amount of principal you can borrow with the down payment you have available will help you determine the maximum price range for homes you can afford. Keep in mind that lenders generally prefer to see a debt-to-income ratio of 36% or less, although some may allow a higher ratio, up to 40-43%, depending on your credit score and other factors.

Property taxes and insurance

In addition to your monthly mortgage payment, you'll also have responsibility for property taxes and homeowners' insurance.

Property taxes are based on the value of the home, and usually paid once or twice a year, although your lender may provide the opportunity to roll them into your monthly mortgage payment. Property taxes vary by state, and even county or city, so it's important to understand local rates. But, for estimation purposes, the average property tax rate in the US is about 1.1%.

A homeowners insurance policy will be required by your lender, but it's also just a good idea for such a large investment! Typically, these policies include damage to your home as well as liability coverage should anyone get hurt on your property. Depending on where you're buying, it's also possible your lender will require an additional flood insurance policy. Premiums for a typical homeowner's policy will be around .5% of your home's value each year, though costs can vary widely based on home location.

Other costs of homeownership

As a homeowner any maintenance or repairs are your responsibility to fix. An often-used rule of thumb is to estimate your maintenance costs will be about 1% of your home's value each year. You also be responsible for all utilities, many of which may be new to you, like garbage and water, if you've been a long-time renter.

After you purchase a home, it's important to have cash reserves on hand to handle unforeseen expenses and emergencies (in fact, your lender may require it!). Experts recommend having enough cash reserves to cover at least three to six months of living expenses. This can provide you with the financial security you need to make monthly mortgage payments and handle unexpected expenses.

Wrapping it all up

When it comes to buying a new home, being realistic about what you can afford is key to avoiding financial stress and ensuring you can enjoy your home for years to come. However, even with careful planning, finding a home that meets your needs and fits comfortably within your budget can be challenging.

If that proves to be true, programs like Crib Equity that co-invest in your home for a share of your home's future value can help. Lowering your monthly payments or increasing the price of the home you can afford can make it easier to find a home without stretching your budget or sacrificing the features and amenities that matter most.