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Chapter 3: Setting Your Price Range

The path to homeownership involves understanding what you can afford.

What Can You Really Afford?

The ratios lenders use to determine what you can afford are necessarily impersonal. Different people with similar incomes and net worth may have different lifestyles and spending habits, so you’d be wise to verify what you actually spend each month and determine for yourself what maximum principal, interest, taxes, and insurance (PITI) you can comfortably afford. It may be more, or less, than the standard based solely on your income, long-term debt, and net worth.

Consider Your Down Payment

To determine the maximum down payment you can afford, first calculate the total dollar value of the following four items:

  1. Money you’re saving for emergencies.
  2. Your closing costs—normally 3–5% of your purchase price. Typically you have to write a check for this amount; however, you can have either the seller or your lender pay your closing costs.
  3. Cash to improve and furnish your new home.
  4. Assets you can’t or won’t liquidate, such as jewelry, life insurance, and retirement funds.

Then, subtract the total from your net worth. The result is your maximum down payment.

Setting Your Price Range.

If any of the money you are planning on using for a down payment is tied up in assets such as real estate or jewelry, allow plenty of time to sell or borrow against them.

Remember that you will need a portion of your down payment as “earnest money.” This is typically a payment of $1,000 that you give the seller’s realtor when you make your offer to show your commitment. Also, as much as 5% of the purchase price (minus the $1,000 in earnest money) is due approximately 10 days after the offer is accepted, to be held in escrow until the closing.

Most loans require a down payment of at least 3% to 5%, depending on the type and term of the loan, although 100% financing loans may be available. Making a 20% down payment frees you from mortgage insurance premiums and may qualify you for some fast-track financing programs.

Making a bigger down payment lowers your monthly mortgage payments and cuts down the interest you’ll pay during the life of the loan. However, you could try another tactic: make a smaller down payment, and then invest the funds you have available so that they earn more than the interest rate on your loan plus the mortgage insurance premium. A smaller down payment also gives you higher tax deductions for mortgage interest.

Ratios and Budgets to Help Assess Affordability

Determine what monthly payment you can afford by creating a basic budget that lists your gross monthly income minus long-term debts, plus any special liabilities you might have, like unusually high medical bills.

Start with your gross monthly household income. Many lenders set a ceiling where you can spend no more than 28% of your gross monthly income on principal, interest, taxes, and insurance (PITI). These ratios vary with lenders, however some may allow your maximum monthly payment to be as high as 33% of your gross monthly income.

Lenders also take into account your other long-term debts such as car loans, alimony, or student loans. They allow no more than 36% of your gross monthly income to be spent on PITI and long-term debts (again, this varies by lender, with some allowing as much as 38%).

Ratios and Budgets to Help Assess Affordability

What Does The Future Hold?

Take a look at the future: do you see any of these common scenarios heading your way?

No one has a crystal ball, but you don’t want to overextend yourself financially—you want to buy what fits both your needs and your budget. Your real estate agent will help you assess your personal situation and determine a budget range based on your present and future goals.

Ready To Get Started?

Let our powerful website connect you to our network of Chicago homes, tailored to your specific needs. Dream Town brokers take great pride in their high client service standards, and are always there to help you navigate Chicago’s diverse market. You’ll benefit from the guidance of your dedicated Dream Town real estate expert throughout the entire process.

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