If you’re earning $200,000 per year, you’ve reached elite status in this country. That’s nearly triple the median income of American workers, which per the latest U.S. Census data is $70,784. But what does that level of income really mean for your home buying power? How much house can you afford on a $200,000 income?
Salary is merely one factor when it comes to determining how much you can afford to spend on a home purchase. Many other parts of your overall financial picture play a role as well. Your credit score and debt-to-income ratio, for instance, can both impact the mortgage interest rate you’re offered, which has a huge effect on your monthly mortgage payments. Here are some of the factors that impact how much home you can afford.
The 28/36 rule
A common rule of thumb in personal finance, the 28/36 formula refers to the ratio between your gross income and your total debt responsibilities. Ideally, your monthly housing costs should not exceed 28 percent of your gross income, while your total debt payments should not be greater than 36 percent of your income.
“The debt portion of the formula includes such things as car payments, student loans, credit cards, medical debt and even monthly payments for child daycare,” says Jack Kammer, vice president of mortgage lending for OriginPoint. “What’s not included is utilities, cable and phone bills.”
If you’re earning $200,000 annually, your monthly gross income is likely to be about $16,666. Applying the 28/36 rule, your monthly mortgage payment should be no more than $4,666, which is 28 percent of your gross monthly pay. Your debt payments meanwhile, should be no more than 36 percent of $16,666, which would amount to about $6,000.
According to Bankrate’s mortgage calculator, purchasing an $800,000 home with a 20 percent down payment and a 30-year-fixed mortgage at 6.5 percent interest would yield monthly principal and interest payments of just over $4,000. That leaves around $600 per month to account for property taxes, homeowners insurance premiums and potential HOA fees to get you up to approximately $4,666 per month. So following this rule, you should be able to afford a home of about $800,000.
Following the 28/36 rule in the current housing market however, which includes high mortgage interest rates that are driving up monthly mortgage payments, can be somewhat challenging even for high earners. “Though the 28/36 rule is an admirable goal, it can be unrealistic in light of home prices and lack of inventory,” says Kammer. In today’s market, “assuming a 20 percent down payment and a 30-year fixed-rate mortgage, a household earning $200,000 might be able to afford a home with a purchase price of around $735,000,” says Kammer.
How much house can you afford?
The 28/36 rule is a good starting point when gauging how expensive of a home you can reasonably afford, but there are several other variables that will have an impact as well. Keep in mind that location can make a big difference as well — your money will likely go a lot further in a small town than it will in a big city, for example. Consider the following when figuring out your budget:
Down payment
The more money you bring to a home purchase upfront, the less you’ll need to borrow, which in turn reduces your monthly mortgage payments. A 20 percent down payment is the benchmark conventional lenders often (but not always) like to see, and it’s a good goal to aim for if you want to reduce your monthly mortgage payments in a high-rate environment like we have today.
To be fair, however, not all mortgages require such a substantial down payment. There are many mortgage options that allow for just 3 percent, while some don’t require a down payment at all. There are also many programs that provide down payment assistance, though with a $200,000 salary, you are unlikely to qualify for them. Still, homebuyers who do not provide 20 percent will be required to pay private mortgage insurance, which adds to your monthly mortgage payment total.
Credit score
Your credit score is critical to the mortgage rate you will receive. The better your score, the more competitive interest rate and loan terms you will likely be offered. Most conventional loans require at least a credit score of 620, though higher is always better.
“Credit scores wield significant influence over interest rates,” says Kammer. “Even a marginal 0.5 percent disparity in rates can result in a $200 payment swing. This is typical when comparing rates with a 760 credit score to a 680 credit score.”
Debt-to-income ratio
Your debt-to-income ratio is another factor that lenders weigh carefully. You can calculate it by dividing the total of all your monthly debt payments by your monthly gross income. The resulting percentage is your DTI, and it helps lenders gauge not only how you handle debt, but also how much of a mortgage you might be able to afford.
“Mortgage lenders adhere to a distinct debt-to-income ratio, some of which extend beyond 55 percent,” says Kammer. “However, our clients typically maintain a debt-to-income range from 20 to 45 percent.”
Home financing options
There are many financing options available for a home purchase, though your high salary may make you ineligible for some. The most common mortgage options include conventional, VA, USDA and FHA loans.
Conventional mortgage loans are not guaranteed by the government. These loans, available through banks, credit unions and online lenders, typically have stricter qualification requirements than those associated with government-backed loans.
Mortgages backed by the government include VA loans, USDA loans and FHA loans. VA loans are for military service members, veterans and eligible spouses. USDA loans, which are guaranteed by the U.S. Department of Agriculture, target individuals whose annual income is below a certain threshold and who are seeking to purchase a home in an eligible rural area. FHA loans are insured by the Federal Housing Administration and can be a good choice for first-time buyers or applicants whose credit score is less than ideal. However, these loans require having mortgage insurance, which is an added expense to keep in mind.
First-time homebuyer programs are widely available for those who need a bit of financial help — but again, a $200,000 salary will probably mean you don’t qualify for such assistance.
Next steps
Considering all of the factors that may impact your homebuying power is an important first step in the homebuying process. Getting preapproved for a mortgage is an easy first step toward helping you understand how much house you can afford. A lender will examine your financial situation —looking at things like tax returns, pay stubs and bank statements —to tell you how much they are likely to be willing to loan you. That number will help you narrow down your home search and know what price range to look at. Taking this step will also put you in a position to act quickly if you come across a home you want to make an offer on.
Finding a real estate agent who knows the area well is another important piece of the puzzle. A Realtor can help identify homes within your budget and provide critical advice when it comes time to make an offer and negotiate a deal. To start your search, ask friends and family for recommendations. And be sure to interview a handful of agents before signing a contract to work with anyone. Asking for references can also be a great way to ensure the professional you’re considering is someone who has a track record of happy clients.
