Two-thirds of American adults own a home, a milestone still considered an important part of the American Dream. Yet buying a home in 2024 often feels out of reach.
The median price of a new home has risen to $495,750, according to the National Association of Home Builders, leaving 77 percent of U.S. households out of pocket. Meanwhile, the Census Bureau found the median household income to be $80,610. Given that gap, how do the millions of first-home buyers achieve that dream each year?
Despite rising costs, experts say there are still affordable housing options, depending on where you look and how you plan.
“The really obvious factor that affects housing affordability is the price of the home itself,” said Danielle Hale, chief economist for Realtor.com. “But there are two other factors that are really important to housing affordability. One is mortgage rates. The other big factor, of course, is income. Those are the three prongs of housing affordability.”
Since the pandemic, mortgage rates have risen sharply, exacerbating the affordability crisis.
“Home prices rose excessively during the pandemic, and mortgage rates followed suit, rising even higher than we’ve seen in the previous decade,” said Logan Mohtashami, chief analyst at HousingWire.
Read more: Should You Buy a House? How Do You Know If You’re Ready?
There is some relief in sight with a rate cut from the Federal Reserve on the horizon, which will indirectly result in lower mortgage rates. However, it could take several weeks for the full impact to be felt by potential homebuyers, so buyers shouldn’t rush into the market for fear of missing out.
Home affordability is a very personal decision. Determining how much home you can actually afford starts with some basic information to help you determine what your major upfront and monthly costs should reasonably be.
How to calculate affordability: the key numbers you need to know
One of the best ways to calculate how much house you can afford is with a home affordability calculator.
To get started, you’ll need to have the following information on hand:
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Gross household income: your annual income before taxes
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Debt: Monthly payments on loans and credit cards
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Down payment: the portion of the purchase price of the home that is paid in advance
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Loan term: the term of the loan (e.g. 15, 20 or 30 years)
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Interest rates: The cost of borrowing, which changes based on your credit score and market trends
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Mortgage Insurance: An insurance that protects the lender if the borrower defaults
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Property Tax: This varies by location and is based on the appraised value of the home.
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Closing costs: the costs associated with the mortgage, title and other fees
Lenders will want to know your debt-to-income ratio (the percentage of your monthly income that goes toward paying off your debt) to help them assess whether you can afford a mortgage.
Hale advises following the “30% rule,” which suggests keeping housing costs within 30% of your gross income. However, she recommends adjusting this figure based on your personal financial situation.
Determine your down payment and loan term
After you’ve calculated your debt-to-income ratio, the next step is to determine how much of a down payment you can afford.
Typically, the down payment is the largest expense when purchasing a home. For example, if you have $10,000 saved, that is your potential down payment, minus any emergency savings you have set aside.
You also need to factor in closing costs (a range of fees related to the loan, title, and other costs). These fees typically range from 2% to 6% of the total purchase price.
Next, consider the term of the loan. Mortgage terms typically range from 15 to 30 years. Mohtashami emphasized the importance of meeting with a mortgage advisor early in the process: “Go to a bank and find out exactly what you qualify for. Mortgage rates and home prices fluctuate, but you need to get that clear number first.”
Loan Options for First Home Buyers
First-time homebuyers often have a variety of loan options, the most common of which are conventional loans and Federal Housing Administration (FHA) loans. “Conventional loans refer to anything backed by Fannie Mae or Freddie Mac, while FHA loans are backed by the Federal Housing Administration,” Hale explained.
FHA loans are better suited for buyers with lower credit scores and higher debt-to-income ratios because they allow for a smaller down payment. Conventional loans, on the other hand, require a higher credit score and at least a 3% down payment. If you opt for a conventional loan without a 20% down payment, you will also have to pay for private mortgage insurance (PMI), which will increase your monthly costs.
Read more: What are the best mortgage loans for first-time home buyers?
For example, let’s say a potential home buyer has a gross annual household income of $100,000, monthly debt payments of $500, and a down payment of $10,000. If we plug this information into the home affordability calculator, what house price would be affordable?
Assuming a 30-year fixed-rate mortgage with an interest rate of 5.795%, along with property taxes and PMI totaling $475 per month, the maximum affordable home price would be $329,728. This would result in a monthly mortgage payment of $3,000, leaving $3,500 each month for savings and other expenses.
If this payment exceeds your monthly budget, you can reduce the house price to ease the financial pressure.
Mohtashami reminds potential buyers that many people start small: “Typically, you buy a smaller house, and as your family grows or your needs change, you move up or down.” This gradual approach is common for many homeowners.
Planning Your Journey to Home Ownership
Owning a home may seem daunting, but with careful planning, it is still possible. By understanding your financial situation, calculating what you can afford, and exploring different mortgage options, you can find a path to homeownership that is right for you.
It’s important to note that buying a home is a transaction, while owning a home is an ongoing budgeting consideration that goes beyond the monthly mortgage. Save 1% of your home’s purchase price for repairs and maintenance, because those costs are yours too.
A less predictable monthly expense is the impact of climate change and extreme weather events on buyers’ ability to pay rising monthly insurance premiums or obtain coverage at all.
“It takes time and preparation to get into the housing market, so take those small steps to save and prepare now to get your finances in order so that your credit score is good and you can qualify for some of the best mortgage terms when you do go to buy a home,” Hale said. “Then of course, anything you can do to improve your income, whether that’s focusing on your career or getting a side hustle, can also help you achieve that dream of homeownership sooner rather than later.”
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