Many people living in the United States often wonder how much money they need to earn in order to buy a house. After all, your annual income somehow determines how much the bank or lender is willing to provide for your home loan. However, lenders also take into account your existing debts and monthly payments to determine whether you can take on additional debt. Other factors, such as the type of loan you apply for, the interest rate, and even the down payment, can also have an impact on your monthly payments. To better understand how all of this works, keep reading.
Income, Expenses, and Debts
The relationship between your income and your debts is known as the Debt-To-Income Ratio (DTI), and it plays a crucial role in deciding how much lenders are willing to lend you. Your DTI is the total amount of your monthly debt payments divided by your household’s total monthly income. This ratio is expressed as a percentage.
For example, let’s say you have three monthly payments to make:
- $800 for rent
- $150 for credit card payments
- $200 for car loan payments
So, the total comes to $1,150. Now, let’s consider that your total monthly income before taxes is $3,000. Your DTI is calculated by dividing your debts by your income, which in this case is $1,150 divided by $3,000. This equates to a DTI of approximately 0.3833 or a 38.33% DTI.
The Importance of Debt-To-Income Ratio in Buying a House
Instead of asking yourself how much you should earn to buy a house, you should focus on calculating your DTI. This percentage tells lenders whether you can take on additional debt and whether you are in a position to do so. Lenders generally prefer to see DTI ratios of 50% or less. This means that when you add up all of your monthly payments, they should be less than half of your gross income.
Other expenses included in your DTI may consist of monthly insurance costs, student loan payments, personal loan payments, alimony, and child care payments.
If your ratio is too high, start looking for ways to reduce your monthly budget or increase your income.
What Percentage of Your Income Should You Allocate to Your Mortgage?
When you qualify for a home loan, the lender will assess your DTI and provide you with a credit line up to a certain amount. However, it’s up to you to decide how much debt you want to take on and what percentage of your income you want to allocate to your mortgage.
Although each situation is different, it is generally not recommended to allocate more than 28% of your income to your mortgage. Just because you qualify for a certain amount of money doesn’t mean you have to take it all. Remember that in addition to the mortgage cost, you will have to pay for insurance and taxes each month.
Calculate Your Monthly Payments
As of June 2023, the average price of a home in the United States is $402,600. With a 20% down payment, you can expect to pay approximately $2,051 per month for the mortgage (at an annual interest rate of 6.5%). This means that, according to the 28% rule, you should earn at least $7,325, considering the combined income of your household. That amounts to $87,900 per year.
Keep in mind that these values are based on the average price of a $402,600 home. If you can find a house for less than that, the income requirement will be lower.
Always consult with a trusted financial advisor who can help you design a personalized investment plan and savings strategies to achieve this goal. Good luck!