You’ve got steady income, a chunk of money saved up, and you’re starting to feel confident about your finances. You think you might even be ready to jump into homeownership once and for all. The only problem? You’re not entirely sure if you can afford to take the plunge. And you’re asking yourself: How much mortgage can I afford?
The truth is, home affordability can be a surprisingly complex concept, with a lot of different variables to consider. How do you know how much money you can borrow for a home loan? What factors does the lender look at when deciding how much to loan you? What’s even included on a mortgage payment? And how can you make sure you’re not overspending on your mortgage?
If you’re feeling overwhelmed, you’re not alone — and you’ve come to the right place.
We’ve enlisted the help of Richard Helali, mortgage sales leader at HomeLight Home Loans, to walk through the basics on home affordability. Here’s what smart buyers need to know.
What’s home affordability?
The term “home affordability” sounds pretty straightforward. It’s how much home you can afford, right? Well, kind of.
How much you can afford to spend on a mortgage is partly a personal decision, based on your own unique financial situation, plus your savings and investment goals.
But there’s actually another dimension to home affordability, and it’s the one we’re going to focus on here: how much you can borrow for a mortgage. As in, how much you can afford according to the lender.
A lender has to protect their investment and minimize risk, so they only lend money to qualified buyers, and only up to a certain point. Who’s a qualified buyer, and what is that point? We’ll get to that soon!
For now, it’s important to understand that what you think you can afford and what the lender is willing to lend you may be two different things. Both factor into home affordability.
How do lenders decide how much mortgage you can afford?
Before diving into the specifics of what lenders are looking for, it’s a good idea to unpack one of the big reasons why lenders look for certain qualifications in buyers in the first place.
Most mortgages, after they’re issued to buyers, are bundled together and sold through the secondary mortgage market.
But why would a lender turn around and sell a mortgage it just worked so hard to get? To create liquidity (that is, more cash flow), which allows the lender to make even more mortgages.
Think about it this way: The lender doesn’t want all their money tied up in just a few loans. It’s much more profitable to sell those loans and use the proceeds to then issue more loans. This is one way mortgages remain accessible to everyday buyers.
Okay, so who buys these mortgages on the secondary market? Mostly, they’re purchased by the government-sponsored enterprises Fannie Mae and Freddie Mac. And because Fannie and Freddie guarantee purchase of these mortgages, the loans are also required to meet certain guidelines — think minimum credit scores and down payment amounts, among other qualifications.
All of that is to say, in order to qualify for a mortgage, you’ll have to meet these minimum requirements. Let’s take a look at six major factors that will affect your home affordability, according to the lender.
Naturally, your income will play a huge role in how much home you can afford. The lender will look at your income alongside other factors, like your monthly minimum debt payments (in other words, your other financial obligations — more on this soon) and your down payment amount, to determine the maximum you can safely borrow.
All other factors being equal, a buyer who makes $10,000 per month will qualify for more mortgage than a buyer who makes $2,000 per month. So keep this in mind as you think about affordability: You are typically only able to borrow in proportion to your income.
2. Monthly debts (DTI)
Similar to how you can only borrow money for a mortgage in proportion to your income, you can also only borrow in proportion to your monthly debts. That is to say, the more money you owe each month in debts that aren’t mortgage payments, the less you’ll be able to borrow for a mortgage.
That’s because your lender looks at your debt-to-income ratio, or DTI, to help determine how much they can safely let you borrow for a mortgage.
“Debt-to-income ratio falls under the ATR rule, which is the ability to repay,” Helali explains. “It looks at your income versus your debts on a monthly basis, including your new mortgage payment, along with taxes and insurance.”
According to Helali, lenders who provide the majority of mortgages, such as those backed by Fannie and Freddie, have to prove that every borrower has the ability to repay based on their income.
With a conventional loan — the type of loan most buyers use — the maximum DTI is normally 45% to 50%, assuming you meet all other loan qualifications (buyers with lower credit scores and savings may have a lower maximum DTI).
Let’s say your household makes $10,000 per month before taxes.
Your total mortgage payment (including monthly taxes and insurance) plus your monthly minimum debt payments (car payments, student loans, credit cards, and so on) can’t exceed 50% DTI, or in this case, $5,000.
Note that government-backed options like USDA, FHA, and VA loans have their own DTI rules. Be sure to check with your lender on updated DTI guidelines by loan type.
3. Savings and down payment amount
The lender will also look at your savings and down payment amount when evaluating how much mortgage you can afford.
If you have a sizable savings and plan to make a larger down payment, you’ll usually qualify for more mortgage. Likewise, if you have less money saved and need to make a smaller down payment, you’ll probably qualify for less mortgage.
Why is that? The more you put down toward the home, the less you need to borrow, and the lower your monthly mortgage payments are.
Because your maximum mortgage payment is proportionally tied to your income and debts, this would allow you to borrow more money overall — spread out over 30 years of mortgage payments — to meet that monthly maximum.
There’s another big way your down payment amount relates to home affordability. If you use a conventional loan and put down less than 20%, you’ll likely be required to pay private mortgage insurance (PMI), which protects the lender in case you default on your loan.
PMI tends to cost between 0.5% and 1% of the loan amount annually, and you can stop paying it when you’ve contributed at least 20% toward the loan principal amount. Still, the lender will factor in the cost of PMI into your maximum monthly payment amount.
4. Credit score
Your credit score is another major factor that affects home affordability. That’s because your credit score is tied to the interest rate you’re offered by the lender, which then directly affects your payment amount each month.
The better your credit score, the lower your interest rate, and the lower your monthly payment. And that lower monthly payment means you can afford to borrow more money proportionate to your income.
Meanwhile, a buyer with a lower credit score will be offered a higher interest rate, which would lead to a higher monthly mortgage payment, and they’d likely qualify for less money overall.
Let’s look at how this plays out for two buyers with different credit scores getting a $300,000 loan.
Buyer A: 780 credit score
Monthly mortgage payment: $1,198
Buyer B: 630 credit score
Monthly mortgage payment: $1,462
That’s an 18% difference in monthly payment!
In fact, our 780 credit buyer could get a loan for $365,000 and they’d owe just about the same in mortgage payments each month ($1,458) as the 630 credit buyer for a $300,000 home ($1,462).
This is just one illustration showing how much your credit score can impact home affordability.
5. Location and property type
Different locations and property types have varying implications for the affordability of your mortgage.
One big reason for this is the variability of property taxes. Some towns have much higher tax rates than others. Annual property and school taxes are usually divided up into 12 equal amounts and then rolled into your mortgage payments each month. Depending on your town, this could add anywhere from a few hundred to a few thousand dollars to your bill each month.
Condos and housing developments may also require additional homeowners association, or HOA, payments. The lender will factor this cost into your maximum budget as well.
“If somebody’s buying a condo or a townhome and that particular property has an HOA associated with it, then that number also has to be added into the calculation of the debt-to-income ratio,” shares Helali.
Two condos could have the same exact price point, yet be in buildings with wildly different HOA costs, amounting to hundreds or even thousands in extra housing expenses each month.
“When I was shopping for a condo, I found some properties that were perfect price points, really nice buildings,” Helali explains. “Come to find out later on, some of these buildings were full-service buildings, hotel-like, with HOAs upwards of $2,000 a month.”
Helali’s HOA budget was more like $400 a month, putting these units out of his reach.
Further, certain property types, such as mobile homes or multi-family homes, may come with different rates than what you’d expect to pay for a run-of-the-mill single-family home. That, too, can affect your affordability overall.
6. Mortgage terms
Finally, the mortgage terms you choose — such as interest type and the length of your loan term — will affect your home affordability.
Let’s say you opt for a shorter loan term of 15 years. Your monthly payments will be higher because you’re paying back the money in a shorter time frame. As a result, you may not qualify for as large of a sum, though you will save significantly on interest. Meanwhile, the more standard 30-year mortgage may allow you to borrow more money overall.
For example, adjustable-rate loans offer lower introductory rates for the first five or seven years, allowing you to effectively lower your housing payment for a time. This may affect the maximum amount you can borrow.
The anatomy of a mortgage payment
Another important aspect of affordability that every buyer needs to understand is what’s included in a typical mortgage payment. Your lender will look at all of these monthly costs together to determine your maximum home budget.
- Principal: This is the amount you borrow for the loan, excluding fees, taxes, and interest. So if you’re buying a $320,000 home and you put down $50,000, your loan principal is $270,000.
- Interest: This is what you pay for financing the loan, expressed as a percentage. Each mortgage payment includes interest, though the amount changes over time. Usually, you pay more toward interest in the first few years of the loan. As you make payments and pay down your interest, you start paying more toward the principal over time. This is called amortization.
- Property taxes: As we mentioned above, property taxes are typically rolled into your mortgage payments. The higher your tax rate, the more property taxes will affect your home affordability.
- Mortgage insurance: Depending on the amount of your down payment and what loan type you choose, you may have to pay mortgage insurance. This fee is usually charged as part of your mortgage payment. If you’re using a conventional loan, you can drop mortgage insurance when you have contributed 20% toward the loan principal amount, or it will automatically be dropped by the lender when you have contributed 22%.
- Homeowner’s insurance: Homeowner’s insurance is generally required by the lender if you’re using a mortgage, and the premium is often rolled into your monthly payments. Plans and prices vary, so make sure to shop around for your policy.
Don’t forget HOA fees!
HOA fees are charged by a homeowners association for shared maintenance, repairs, and services. Technically they’re usually paid directly to the HOA — but again, the cost for these HOA fees will be factored into your maximum mortgage budget as though it were part of your monthly payment.
HOA fees can vary widely and really add up, so keep that in mind if you plan to go the homeowners association route.
How to use a home affordability calculator
Using a home affordability calculator is a great way to get a general idea of your maximum home budget, according to a mortgage lender.
“It’s a great first step even ahead of talking to a loan officer,” Helali reveals. “It gives you a high-level gut check of what you could afford.”
Keep in mind that a home affordability calculator is just a rough estimate, and all of your information will need to be verified by a lender before you can get a more accurate picture of your buying power.
But it’s a great place to start if you’re new-home curious and not quite ready to start shopping yet!
What you need to have on hand:
- Gross annual income: This is your pre-tax income, and it can be found on your tax forms or pay stubs.
- Monthly debts: This is the total of your minimum monthly debt payments, including car loans, credit cards, student loans, medical debt, and anything else that shows up on your credit report.
- Savings (with an idea of how much you’ll put down for down payment): How much cash do you have on hand that could go toward a home purchase? Some of it can go toward the down payment, but some will also need to be set aside for closing costs and cash reserves to keep for emergencies after you close on your home.
- Credit score: You’ll also need a good idea of your credit score, which you can often get from your credit card company. Other ways to explore your score include sites like Credit Karma (though note that they’re not always totally accurate), or you could pull your official credit report — you’re entitled to one free copy each year from each of the three major credit bureaus — through the government-sponsored site AnnualCreditReport.com.
Once you’ve got all your information gathered up, head on over to a home affordability calculator (HomeLight’s is super simple to use!) and plug in your numbers. The calculator will provide an estimate of your maximum home budget and a breakdown of what your monthly mortgage payments might look like.
How to think about your affordability once you’ve got your number
Okay, you’ve got your number. Now what? It’s time to think through whether you want to spend up to your limit, or set your own budget based on your unique financial situation and goals.
The reality is, spending 50% of your pre-tax income may not leave you with much left over.
Let’s go back to our example of making $10,000 in household gross income each month. After taxes, you’d likely take home somewhere between $6,500 and $7,000 each month. If you’re spending $5,000 of that on your home loan and other mandatory debt payments, that doesn’t leave you much of a budget for, well, everything else.
“Sit down and budget — preferably with a financial advisor. That way you can better understand what you can afford, because there may be a huge difference between what you can afford and what you should afford.”
It’s important to set a monthly housing budget where you can still comfortably afford other important expenses like food, healthcare, clothing, gas, car insurance, childcare, electricity, heat/cooling, internet, home repairs and maintenance, investments, savings, entertainment, and more.
Another way you can think about budgeting is through the lens of popular personal finance principles like the 28/36 rule. With the 28/36 rule, your mortgage payment shouldn’t exceed 28% of your pre-tax income, and your overall debts shouldn’t be higher than 36% of your pre-tax income.
This rule is more financially conservative than your lender is likely to be. And keep in mind that it may not be realistic for the home prices in your market. Still, it can be a useful tool for helping you assess your different home budgeting options.
Once you’ve thought through your options and you’re ready to go home shopping, you’ll want to get a preapproval. That’s when the lender looks under the hood of your finances, checks your credit, and gives you a more accurate picture of how much you can really borrow for a mortgage.
Other home affordability factors to consider
A few last things before you set your budget and start home shopping!
- Homeowner expenses can really add up. You’ll need to set aside money for maintenance, repairs, buying furniture and decor, and moving. Many homebuyers find themselves surprised by the cost of maintaining a home — don’t be caught off-guard! Experts suggest setting aside at least 1% to 3% of your home’s value for maintenance each year (and that’s to say nothing of repairs!).
- Don’t forget utilities. Electricity, heat, cooling, and gas for cooking can add up substantially, depending on the size of your home, its location, and how dedicated you are to conserving energy. Your agent can help you dig up average utilities costs for each home you’re interested in to give you an idea of how much to budget for these expenses each month.
- Make sure you can still save and invest. Keeping your debts and expenses manageable is great, but don’t forget that you’ll still need to prioritize saving money and investing in your retirement, too. Make sure that whatever budget you set, you can still afford to save and invest in your future.
And finally? If this is all a little too overwhelming, don’t be afraid to ask for help.
“There are no stupid questions,” Helali reminds buyers. “This is likely going to be one of the largest financial decisions that you’re going to make. You deserve to have your questions answered.”