How much mortgage can you afford?
The main thing you and your lender should care about isn’t the total mortgage amount. Rather, you should focus on monthly mortgage payments and whether you can easily afford them.
Lenders use your debt-to-income ratio (DTI) as a measure of affordability. And they see a 28% DTI as an excellent one.
Ideally, that means your monthly mortgage payment (including principal, interest, taxes, and insurance) shouldn’t be more than 28% of your gross monthly income. But lenders can be flexible, so if your DTI is a little higher, don’t worry.
The trick is finding the right loan amount and mortgage program for your situation. Here’s how.
In this article (Skip to...)
- How much should you pay?
- How lenders decide
- How DTI works
- Payment examples
- How to afford more home
- How to calculate DTI
- Costs beyond a mortgage
- Today’s rates
How much should your mortgage be?
Your mortgage should be a loan amount you can comfortably afford in your monthly budget.
So when determining the right size, you have to work backwards — find the right monthly payment first, and calculate the home purchase price based on that number.
When it comes to monthly mortgage payments, one number is key in determining what you can afford: your debt-to-income ratio (DTI).
This number compares your monthly income against your monthly debts to see how much mortgage you could afford alongside your existing payments.
“Keep in mind that your loan officer is going to qualify you on gross (pre-tax) income. Therefore, if your gross DTI is 43% (front-end DTI), you personally may want to consider what it is for your net (back-end DTI),” says Jon Meyer, The Mortgage Reports loan expert and licensed MLO.
Of course, other factors matter too, like your credit score, mortgage rate, and down payment.
But DTI has a huge impact on affordability. So it’s important to understand how mortgage lenders look at this number.
How lenders decide on how much mortgage you can afford
Gross income is your total pre-tax earnings. It’s the combined sum of your salary, interest earnings, benefits, child support, and any other income. What’s leftover after you’ve paid taxes is your net income.
Mortgage lenders factor in your gross income when settling on the monthly mortgage payment you can afford.
Your front-end debt-to-income ratio — also known as your “front-end ratio” or “mortgage-to-income ratio” — is the portion of your annual gross income allocated to paying your housing costs each month. Mortgage-to-income ratio is calculated by dividing your expected mortgage payment by your monthly gross income.
Keep in mind that your total housing payment isn’t just the principal and interest on your home loan. It also includes your mortgage insurance, homeowners insurance, property taxes, and homeowners association (HOA) dues, if applicable.
A general rule of thumb is that your mortgage-to-income ratio shouldn’t exceed 28% of your gross income, but this rule varies depending on your lender.
Back-end debt-to-income ratio
Your total debt-to-income ratio can also be referred to as your “back-end ratio.” This is the percentage of your gross monthly income you spend on inescapable debt obligations. In other words, your total debt.
Your total debt includes payments on your new home, minimum payments on credit cards, fixed payments on car loans, student loans, personal loans and other types of loans, and monthly costs like alimony and child support.
Your DTI is typically determined by debts that show up on your credit report and does not include discretionary spending. So you should not include groceries, gas, utilities, eating out, cell phone and internet bills, and all the other variable spending that you can control each month.
Your interest rate and your chances of loan approval depend heavily on your credit score. Your new home loan will most likely be your largest debt, so improving your credit score could save you more than you think over the life of your loan.
Before you even speak with a loan officer, pull free copies of your credit report from the three major credit bureaus: Experian, Equifax, and TransUnion. You are entitled to a free report each year.
If your scores are low — below 620 — then take some time to improve your credit history.
How debt-to-income ratio affects your mortgage
Why is DTI key to your mortgage loan amount? Because the more you spend on debt obligations, the less money you have leftover for your monthly mortgage payment.
Some types of loans allow higher DTIs than others. But, with most mortgages, lenders will want you to have a DTI of 43% or less.
For example, say you have a monthly gross income of $5,000. You already pay $1,000 per month on existing debts. How much mortgage can you afford?
- Max DTI: 43%
- 0.43 x $5,000 = $2,150
- Max debt payments: $2,150
- Existing debts: $1,000
- Max home expenses: $1,150
Now you know you can only afford a new home if the total monthly payment comes out to $1,150 or less.
Remember to include property taxes, homeowners insurance, and private mortgage insurance (PMI) when estimating your monthly mortgage payment.
Depending on your lender, a DTI above 43% may be allowed.
On some conforming conventional loans, Fannie Mae and Freddie Mac set their maximum DTIs at 45% to 50%. And it’s possible to get an FHA loan or VA loan with up to a 50% DTI.
However, you’ll likely need compensating factors to make up for the high DTI — like a big down payment or a great credit score.
How much should my mortgage be in the real world?
All this math can come across as a bit theoretical. And your goal when deciding on your mortgage amount should be more practical. You want a home loan that will fit neatly within your lifestyle, needs, and ambitions.
Try running a few numbers through a home affordability calculator to begin getting a sense of how much your mortgage should be.
The fact that a lender will give you $x amount — because of your DTI, credit score, down payment, and personal finances — doesn’t necessarily mean you should borrow $x amount.
Yes, most of us borrow up to the maximum we’re allowed. But that doesn’t mean you should.
What are your spending priorities?
Your home buying process all depends on your lifestyle and priorities. Suppose you love foreign travel or gourmet eating or sailing or shopping. Borrowing the max amount might mean you’re sacrificing other luxuries for years to come.
It could be best to settle on a more modest home and a smaller mortgage if that allows you to maintain your current lifestyle.
How secure is your income?
You should also bear in mind how secure your earnings are.
You likely don’t want to be saddled with the biggest mortgage possible if you’re in a job where firings are commonplace — or if you plan to change jobs soon and you’re not sure you’ll earn the same amount.
Lenders have these questions in mind, too. That’s why they typically want to see two years’ employment history on your mortgage application. They also want to know any income you’re using to qualify for the loan will continue for at least three years.
Mortgage payment examples
Here are just a couple examples to show you how factors like DTI and your credit report can affect your home buying budget.
The Mortgage Reports looked into the question: How much income do you need for a million-dollar home? And the answer revealed a surprisingly broad range of earnings.
We found that a prime borrower (with a small DTI, stellar credit score, and 20% down) might be able to buy a $1 million home with a household income as low as $100,000.
But someone with lots of existing debts, moderate credit, and the smallest down payment allowable could need an annual income of $225,000 to afford the same home.
How come? Well, as we just established, your income is only a part of what determines your maximum mortgage borrowing capacity.
Your debt obligations play a big part, as do your credit score and the size of your down payment.
Similarly, we answered the question: How much house can I afford if I make $100,000 per year?
Again, the answers varied widely depending on those same factors: DTI, credit score, and down payment.
- Borrower 1, with a 760 credit score, no existing debts, and a 20% down payment might be approved for a loan of roughly $721,000.
- But Borrower 2, with a 650 credit score, $250 in monthly debt payments, and a 15% down payment might be offered only $561,000.
That’s a difference of $160,000 in the homes these two borrowers can comfortably afford — even though they make the same amount of money.
Also remember that to get the best deal and lowest mortgage rates, you need to be in a stable financial situation. Everyone else pays a bit — or a lot — more.
How to afford a bigger mortgage
You can afford a more expensive home by following three simple steps as you prepare to apply for a mortgage:
- Pay down some debt, especially credit card balances. Not only do you reduce your DTI, but lowering card debt should also improve the state of your credit report
- Save a bigger down payment. The more skin you have in this game, the more lenders like you. A bigger down payment often earns you a lower interest rate and better home
- Work on your credit score. As long as you’re paying bills promptly, credit card balances are often the main drag on your score. Each needs to be below 30% of the card’s credit limit. Also, in the months leading up to a mortgage application, you should avoid opening and closing any lines of credit
Of course, these steps may be easier said than done, especially for a first-time home buyer.
How are you supposed to pay down debt and increase your savings at the same time? Often it’s a struggle to even meet monthly expenses.
But nearly everyone — at least, nearly everyone with homeownership plans — can find some savings in their household budgets. And it’s surprising how often just a small improvement in your DTI, down payment, or credit score can make a big difference to the mortgage deal you’re offered.
So do what you can. But if your financial situation isn’t perfect, don’t let that stop you. Mortgage loan programs today are flexible, and you might be surprised at what it takes to qualify.
How to calculate your DTI
We talked a lot about debt-to-income ratios in this article. Knowing yours is key to learning how much house you can afford.
So, in case you were wondering, here’s how you can calculate your own DTI ratio for mortgage qualifying.
- First, add up all the monthly expenses included in your DTI:
- Estimated monthly housing expenses (you can use a mortgage calculator for this)
- Minimum credit card payments
- Car payments
- Other monthly loan payments
- Obligations like alimony and child support
Next, you need to know your gross monthly income.
Remember, that’s the highest figure on your pay stub, before deductions for tax and so on. If your income varies considerably — perhaps seasonally — use an average over the last year or two.
Now, divide the first figure (total monthly debt) by the second (pre-tax income).
Federal regulator the Consumer Financial Protection Bureau gives an example:
“If you pay $1,500 a month for your mortgage and another $100 a month for an auto loan and $400 a month for the rest of your debts, your monthly debt payments are $2,000. ($1500 + $100 + $400 = $2,000.)
“If your gross monthly income is $6,000, then your debt-to-income ratio is 33 percent. ($2,000 is 33% of $6,000.)”
If you use a calculator, you’ll need to multiply the result by 100 to get a percentage. So your display says 0.3333 but your DTI is 33.33% (33% when rounded by your lender).
Homeownership cost beyond your mortgage loan
Keep in mind that there are additional expenses to homeownership, beyond your monthly loan payment, mortgage interest rate, and closing costs.
When determining how much mortgage you can afford, factor in these unavoidable costs.
Your home insurance policy will protect your household from disasters, theft, and other damaging events. Many mortgage lenders require that your policy cover the purchase price of your new home.
On average, home insurance premiums are around $1,200-$1,500 each year. So budget accordingly.
Property taxes are an inevitable line item in any homeowner’s budget. Once you pay off your mortgage in full, you will still be responsible for paying property tax.
Property taxes vary according to the state you live in. Some states have higher property taxes than others, but some estimates claim that the average rate nationwide is 1.1% of a home’s assessed value.
Your utility costs are generally not figured into your front-end ratio or your back-end ratio. Yet, all owners are responsible for a long list of utility bills such as electricity, gas, heat, sewage, water, trash removal, and so on.
And, if you just purchased a 5-bedroom suburban castle, instead of a modest starter home, then prepare yourself for increased utility costs.
While it can be difficult to pinpoint the exact amount of money home maintenance will cost you on a monthly or even annual basis. Rest assured, all homeowners will need to repair or replace a roof, driveway, water heater, or other appliance at some point.
Many homeowners enjoy the added security of a home warranty, but these types of protections only cover certain repairs.
Bottom line: Be sure you’re not stretched too thinly, month-to-month, that you cannot call a plumber when your sewer line backs up unexpectedly.
Homeowners association fees
Condominiums, townhomes, gated communities, and planned developments often have a homeowners association (HOA) that assesses monthly or annual fees that will vary depending on the services it offers.
Additionally, homeowner association fees can increase over time. So while your HOA dues were only $150 a month when you originally purchased the home, those costs could climb annually.
What are today’s mortgage rates?
Today’s rates are still low, which is good news for home buyers. The lower your interest rate, the more real estate you get for your dollar.
Remember, there’s no ‘perfect’ amount to spend on your home loan. The decision is personal — it depends on how much you make, how much you currently spend each month, and how large of a housing payment you’re comfortable with.
So explore your options, check your rates, and pick the right mortgage amount for you.