Once you’ve decided which mortgage loan type works best for you, you’ll want to begin thinking about your monthly budget and how much home you can afford.
Start by determining your budget for a monthly mortgage payment.
For this example, let’s say you’re aiming for a mortgage payment of $1,500 per month.
We’ll now work backward to determine your maximum home purchase price.
Calculate your monthly mortgage payment (PITI)
Your mortgage payment is made up of four parts, collectively known as PITI — Principal, Interest, Taxes, and Insurance.
- Principal and Interest — Principal and Interest make up your basic mortgage payment, including your payments toward the loan balance and interest paid to your lender
- Taxes — As a homeowner, you’re responsible for paying annual property taxes to the local taxing authority. Property taxes typically range from 1 to 2 percent of your home’s value annually
- Insurance — Then, there’s homeowners insurance. Mortgage lenders require that you carry insurance for your home, which typically costs 0.25 to 0.50 percent of your home’s value annually
Some neighborhoods have homeowners’ associations that charge monthly dues; for this example we’ll assume you won’t include HOA dues in your monthly housing budget.
So, assuming a home purchase price of $250,000 and a 10 percent down payment, plan on setting aside $400 for taxes and insurance each month.
This leaves about $1,100 to spend on principal and interest.
Find your mortgage rate and price range
Determining whether a home is “in budget” depends on your mortgage rates, too.
Be aware that mortgage rates move up and down all day, every day. Over the course of weeks and months, rates can change by 50 basis points (0.50 percent) or more.
When you’re home shopping, especially over an extended time period, it’s important to observe mortgage rates and how they are trending.
Consider the above example, when you have budgeted $1,100 to spend on principal and interest each month.
- With mortgage rates at 3.75%, the payment is $1,043. The home is ‘in-budget’
- With mortgage rates at 4.25%, the payment is $1,107. The home is ‘out-of-budget’
This example shows why you should never base your home search on a price range.
The same home is affordable when rates are low, and unaffordable when rates increase.
Adjust your target price range based on current mortgage rates. It’s the only true way to keep on budget.