Buying a home is often the most expensive investment you’ll make in your lifetime, so it’s essential to ensure your monthly mortgage payments are affordable. Figuring out how much mortgage you can afford isn’t as simple as determining what the bank is willing to lend you. Besides affordability, it’s also wise to take your financial needs and goals into account.
If you’re planning to buy a new home, we’ve created this useful guide to help you determine how much mortgage you can afford and what factors are essential to consider.
How much mortgage can I afford?
When determining how much mortgage you can afford, a good place to start is with the 28/36 rule. Under this widely accepted rule of thumb, homeowners should not spend more than 28% of their gross monthly income on housing costs and 36% on their total debt — including the mortgage, credit cards, car loans, student loans, and other monthly debt payments.
Lenders often consider the 28% and 36% figures to be in the acceptable range for borrowers. These figures are related to debt-to-income ratios, which we’ll discuss in a moment.
Let’s take a look at how to determine and apply the 28/36 rule: Say, your gross (before taxes) monthly income is $8,000. First, multiply 8,000 x 28, which is 224,000. Next, divide that number by 100, so 224,000 ÷ 100 = 2,240. This represents 28% of your gross income. In this example, an affordable total monthly mortgage payment would be $2,240.
To determine the 36% number, substitute “28” with “36” in the preceding formula, and you get $2,880. So your housing expenses plus all other recurring monthly debt payments would need to be less than $2,880 to satisfy the 36% portion of the 28/36 rule.
Online calculators are another valuable tool to help you understand a mortgage amount that is doable with your budget. Many of the best mortgage lenders offer home affordability calculators, and you can also find them on real estate marketplaces like Zillow and Realtor.com.
With most home affordability calculators, you’ll enter your income, monthly debt, location, and a down payment amount. More extensive calculators may also ask for some of the following information:
- Debt-to-income (DTI) ratio
- Interest rate
- Loan term
- Property tax
- Home insurance
- Homeowners association (HOA) dues
The 28/36 rule and home affordability calculators can provide you with a starting point to help determine how much mortgage payment you can afford. From there, you’ll need to factor in your own unique financial needs and objectives to figure out a number that makes sense for you.
What lenders consider when you apply for a mortgage
Underwriters generally consider your gross annual income, DTI ratio, credit profile, and assets when you apply for a mortgage loan.
1. Gross annual income
Your gross annual income is the total amount of money you earn each year before deductions are withdrawn from your paycheck. In other words, if your yearly salary is $70,000, that is your gross annual income, even though paycheck deductions leave you with less than $70,000 in take-home pay.
Your gross annual income includes your earnings from your job or business, but can also include disability benefits, Social Security benefits, alimony, and child support payments.
Another important thing loan underwriters consider is your debt-to-income (DTI) ratio. Your DTI ratio is the percentage of your monthly gross income that goes toward your monthly debts. Lenders place great importance on this metric to ensure that borrowers can afford their monthly mortgage payments.
Lenders consider two types of DTI ratios: front-end and back-end. Front-end DTI includes your housing-related expenses only. These align with the 28/36 rule. Lenders generally don’t want more than 28% of your monthly income to go toward your housing expenses, which include the principal, interest, property taxes, and insurance (PITI) on your property.
If your monthly gross monthly income is $6,000, that means your mortgage payment should be no more than $1,680. In this example, the front-end DTI is determined by multiplying your total monthly income by 28%: $6,000 x .28% = $1,680 in recommended monthly housing costs.
Unlike front-end DTI, which accounts for housing costs relative to your income, back-end DTI considers your total monthly debts, including the proposed mortgage payment. Generally, lenders require your long-term debt, including the mortgage, car loans, student loan payments, and other debts, to be less than 33% or 36% of your monthly gross income.
In this case, if your gross monthly income is $6,000, then the total of your mortgage and other outstanding debts should not be higher than $2,160 as $6,000 x .36% = $2,160.
3. Credit profile
Many mortgage lenders follow a formula to help them assess risk. These formulas vary by lender, but they often rely on the homebuyer’s credit score. Typically, homebuyers with high credit scores receive loan offers with lower interest rates.
Since interest rates impact the amount of your monthly payment and the overall cost of the loan, it pays to have good credit. Before you apply for a mortgage, it’s a good idea to check your credit report from the three leading credit reporting agencies — Equifax, Experian, and TransUnion. You can get one free copy of your report each year from AnnualCreditReport.com.
Carefully review your reports, looking for errors and inaccuracies. If you spot mistakes, try to remove them by disputing credit report errors with the credit bureaus. The process to remove negative marks takes time, but cleaning up your credit could mean the difference to get approved for a loan or receive a better annual percentage rate (APR).
4. Your total assets
One way lenders consider their risk exposure is by reviewing your total assets. Along those lines, the lender generally wants to see your bank statements, investment accounts, and other sources to determine if you have enough cash reserves to make a down payment and pay for closing costs.
The more high-value assets you have, the less risky your application may appear to lenders. Having valuable assets indicates you’ll likely be able to make on-time mortgage payments each month and that you could sustain a major financial blow such as the loss of your job or a medical emergency.
Factors that impact mortgage affordability
If you’re wondering how to get a loan you can afford, consider a few of the factors that impact mortgage affordability.
1. Interest rate
Perhaps no factor affects a home’s affordability more than the interest rate of the mortgage loan. That’s because it’s the mortgage payment you have to fit in your budget each month, not the loan amount. The lower your mortgage rate, the lower the interest paid on the loan. The lower the interest paid, the more you might be able to afford to borrow.
2. Length of mortgage term
The loan term affects your monthly payment and the total amount of interest you’ll pay over the life of the loan. With a shorter loan term, your payments will usually be higher, though you’ll pay less in interest over time.
Let’s compare costs between a 30-year mortgage with a 3.8% APR and a 15-year mortgage with a 3.25% APR:
|30-year loan||15-year loan|
|Down payment amount||20%||20%|
|Total monthly mortgage payment||$1,118.30||$1,686.41|
|Total interest paid over loan term||$162,587.15||$63,552.91|
In this case, the monthly payments on the 30-year mortgage are over $500 lower than the monthly payments on the 15-year mortgage. However, if you look at the total interest you’ll pay over the life of the loans, you’d pay over $99,000 more in interest with the 30-year mortgage due to the longer term. Both the monthly payment and total interest charges are worth considering as you compare home loans.
3. Total savings
Another factor affecting home affordability is the amount of cash savings you have on hand. This will likely impact how much of a down payment you can afford to make. In general, the higher your down payment, the lower your monthly mortgage payment.
Lenders might also consider how much you have in savings as they are reviewing your loan application. If a borrower has a high amount in savings, it could make them lower-risk in the eyes of a lender.
4. Property taxes
When it comes to the affordability of a mortgage loan, property taxes are an often overlooked consideration. The amount you’ll pay in property taxes is based on the assessed value of the home. Generally, the higher the assessed value, the higher your monthly tax obligation will be.
Property taxes vary depending on where you live. Refer to your county assessor’s website and local real estate listings to get a picture of the property tax rates in your location.
5. Homeowners insurance
Your lender will require you to purchase homeowners insurance to cover potential losses due to things like fires or natural catastrophes. The cost of homeowners insurance can vary depending on where you live. For instance, this insurance generally costs more in places where homeowners file more claims, such as in areas that experience frequent storms.
Speak with a local insurance agent to get an accurate homeowners insurance quote. The National Association of Insurance Commissioners lists the national average annual homeowners insurance premium at $1,249, roughly $104 per month, as a general reference.
6. Private mortgage insurance
Private mortgage insurance (PMI) is a type of insurance that protects the lender if you’re unable to make your monthly payments. Typically, if you’re making a down payment of less than 20% of a home’s purchase price, you’ll be on the hook for mortgage insurance.
PMI increases the cost of your loan. Depending on the lender, you may be required to pay the PMI as part of your total monthly payment, and you could be responsible for paying mortgage insurance costs at closing, too, in the case of FHA loans. More on those loans in a minute.
7. Your personal goals
As we’ve seen, lenders consider your income, debts and expenses, credit and assets when considering whether or not to approve you for a loan. However, they don’t consider your personal financial goals when determining whether a mortgage is affordable. For example, you might have a savings plan for retirement, a child’s education, or to pay off debts.
In other words, just because you can get approved for a specific loan amount doesn’t mean you should choose to do so. It may make more sense to purchase a home with a sales price below your maximum and leave some cushion in your budget.
Low down payment mortgage options
Although some banks and financial institutions have lower down payment requirements, many lenders require a 20% down payment for conventional loans.
If a 20% down payment is an obstacle preventing you from purchasing at home, here are a few alternatives that might have lower down payment requirements:
Federal Housing Administration (FHA) loans are federally-backed mortgages with less stringent requirements than conventional loans. If you’re comparing FHA vs. conventional loans, consider that FHA loans might only require a 10% down payment if your credit score falls between 500 and 579. If your credit score is above 580, you could qualify for an FHA loan with as little as 3.5% down.
FHA loans include a mortgage insurance premium (MIP) that costs 1.75% of the loan amount, due at closing. Additionally, borrowers pay monthly mortgage insurance premiums totaling 0.45%-1.05% of the loan amount per year.
The U.S. Department of Agriculture (USDA) offers loans designed to help home buyers with low-to-average income for their area. These loans require the following:
- FICO credit score of 640 and higher (though it can vary depending on the lender)
- No down payment
- Mortgage insurance — a 1% upfront fee is added to your loan balance and paid with your monthly mortgage payment. Plus, an annual fee of 0.35% of your remaining principal balance each year.
- Home must be in a qualifying rural area
For veterans and service members, VA loans provide an easier path to homeownership than many types of mortgages. That’s because veteran home loans typically don’t require a down payment or mortgage insurance.
Most VA lenders require a credit score of 620 or higher, while others may accept credit scores as low as 580 when considering your eligibility for a VA loan.
What mortgage can I afford with my salary?
A good guideline is that your total mortgage, including your principal, interest, taxes, and insurance (PITI), should not exceed 28% of your pre-tax monthly income. You can determine this number by multiplying your income by 28 and dividing the resulting number by 100.
Can I get a mortgage that's five times my salary?
Income is just one of many factors mortgage loan underwriters consider when evaluating a loan application. When all the factors are considered, including the APR, debt, and down payment, it could be possible to get approved for a loan amount that’s several times your salary.
Is it worth it to get preapproved for a mortgage?
It can be worth it to get pre-approved for a mortgage. Not only will this help you determine how much you could get approved for, but it could also signal to real estate professionals and home sellers you’re a serious home buyer.
When considering how much mortgage you can afford, the 28/36 rule can give you a general number. Mortgage calculators can further refine your affordability range. However, the best way to figure out how much home you can afford is to speak with a local mortgage loan officer.
Remember that just because a lender might approve you for a specific amount doesn’t mean you should opt for that amount. Consider your long-term financial needs and objectives. You’ll be paying on this loan for presumably 15 to 30 years, so you’ll want to make sure there’s room in your budget to save for retirement, college funds, and other goals.