Jump to affordability topics:
– Your Salary Alone Doesn’t Answer the Question
– Your Down Payment and Affordability
– Income vs. Liabilities
– Figure Out Your DTI
– What You’re Comfortable With vs. What the Lender Will Allow
– A Lower Mortgage Rate Means You Can Borrow More
If the term mortgage has crossed your mind recently and you’re in the market to purchase a new home, you’ve probably asked yourself, “How much house can I afford”?
This is a very important question all prospective homeowners should know the answer to well before they begin looking at real estate, whether it’s a single-family home, condo, or townhouse.
Knowing how much mortgage you can afford will allow you to narrow your home search so you can save time and be more productive. And hopefully successful in finding your dream home.
In fact, if you don’t already have a mortgage pre-approval in hand, which essentially details how much house you can afford, most real estate agents won’t take you seriously.
And may not even take you out to see listings. Why? Because home sellers won’t want to waste their time with a prospective buyer that isn’t actually qualified in a given price range.
How Much Mortgage Can I Afford On…50k, 100k, 200k
- You can’t just plug in your income to determine affordability
- You have to consider your other monthly expenses
- Along with your down payment and current mortgage rates
- Don’t forget local property taxes and homeowners insurance!
While the question is often framed as “how much house,” perhaps it’s better to ask “how much mortgage can I afford” instead.
I say that because you could potentially afford to buy all types of homes depending on the size of the down payment.
That being said, it seems a lot of folks want to know what mortgage they can afford based on a certain salary such as $50,000 or $100,000.
Again, it’s not that simple, nothing ever is in the mortgage world. We can’t just look at your income in a vacuum to determine how much you can borrow for a mortgage.
Instead, we need to factor in your monthly liabilities (expenses) such as student loans, credit cards, any current mortgage you plan to keep, and the proposed housing payment (including homeowners insurance and property tax).
Unfortunately, we don’t all have the same monthly expenses or the same annual property tax bill. These things can vary considerably.
For example, if someone makes $100,000 a year in salary, but has sky-high monthly expenses including a pricey Range Rover lease that sets them back $2,000 a month, it may not matter that they’re in the six-figure club.
Their frugal friend who makes a bit less, say only $75,000 per year, but drives a Prius they own outright with no monthly payments will have roughly the same amount of money available for an eventual monthly mortgage payment.
A legitimate affordability calculator will take all these important items into account to ensure you’re actually qualified at a certain purchase price.
Your Down Payment Greatly Affects How Much House You Can Afford
- A low-down payment mortgage can seriously dent housing affordability
- Whereas a borrower able to put down 20%+ will have a smaller loan amount
- Along with a lower mortgage payment each month
- Thanks to a better interest rate and no mortgage insurance in most cases
We also need to factor in the borrower’s down payment to determine the maximum loan amount (and maximum home purchase price) they can afford.
If someone is putting down 20% on a $500,000 home, their loan amount would only be $400,000.
Conversely, if someone is only putting down 5% on the same $500,000 home, their loan amount would be a much higher $475,000.
Now let’s consider the total monthly mortgage payment of each loan, with the 20% down mortgage avoiding private mortgage insurance and receiving a more favorable interest rate.
Borrower A: $400,000 loan amount @4% = $1,909.66
Borrower B: $475,000 loan amount @4.5% + PMI of $150 per month = $2,556.76
As you can see, the down payment alone can change the home affordability equation tremendously. We’re looking at a difference in monthly payment of nearly $650, which is roughly 34% higher.
In other words, even if both borrowers have the same exact salary, their housing payments can vary widely based on how much they’re willing or able to put down on the house, and also what mortgage rates they receive.
Notice the lower interest rate on the smaller mortgage above. Lenders reward those who come in with higher down payments.
Sure, income is important, but so is the loan amount, and it can only be determined by figuring out the down payment.
The more you put down, the smaller your loan amount will be (and monthly payment), and vice versa.
Long story short, we need to look at more than just income…no one will be able to tell you with any certainty what mortgage you can afford just because they know you make X amount each year.
Lower monthly spending and a lower interest rate means a lower home loan payment, which means home affordability can rise for the disciplined and frugal borrower.
For the record, the monthly payments above are based on a 30-year fixed mortgage.
Look at Your Income vs. Liabilities to See How Much You Can Borrow for a Mortgage
- First tally up all your gross income that can be documented
- Then consider all your monthly outlays that can be found on a credit report
- Like car lease payments, credit card payments, student loans and so on
- This is how you determine what’s left over for a housing payment
The best way to determine how much you can afford, or really how much house the lender will let you buy, is to first look at your gross monthly income, and then compare it to all your liabilities.
Underwriters typically ask for the past two years of income to ensure it’s stable and expected to continue for the foreseeable future.
Aside from a typical base salary, your income may also include things like bonuses, overtime, commissions, tips, social security, a pension, disability income, alimony and child support, self-employment income, military income, an automobile allowance, and so on.
Make sure you factor in all sources of income to get the complete picture, but also check to see that they’re acceptable before including them.
Liabilities include anything you have to pay on a monthly basis, including both revolving and installment accounts, which show up on your credit report.
Installment accounts include things like mortgages, student loans, and car leases and loans, which have fixed rates and terms and require regular equal loan payments.
Essentially, you owe a set amount of money each month and have a predetermined amount of time to pay it back.
An example would be a car lease that has terms of 3 years at $200 per month. Each month you pay $200 and you must pay off the entire balance by the end of the 3-year period.
Revolving accounts, on the other hand, offer more flexibility. These include credit cards that allow you to pay a minimum monthly payment, which you can also keep a balance on.
Though you may have a preset spending limit, your balance can vary month-to-month, and thus your minimum payment can change as well.
You have the choice to make the minimum payment, or a larger amount. You can even pay the entire balance off if you so desire (you probably should!).
When calculating your revolving accounts for a mortgage, simply take the minimum payment due.
Get a Credit Report to Determine Monthly Liabilities
- You need a copy of a recent credit report
- To determine the minimum payments on all your liabilities
- A lender will order one and plug in all these monthly costs as well
- To determine your DTI ratio, which is key to eligibility
The next step is getting your hands on a credit report so you can see exactly what each monthly payment looks like for each liability as reported by the credit reporting agencies.
This is important because although you may pay a certain amount monthly, the amount can change and will vary upon different credit reporting methods, so it’s best to view a credit report to see exactly what the credit bureaus see. This is what mortgage lenders will see too.
Also be sure to take into account any monthly payments you make that won’t show up on your credit report, such as gardening services, pool services, and cleaning services to name a few for your own budget.
These won’t count against you when qualifying for a mortgage, but they’re important considerations to ensure you don’t get in over your head.
These costs can actually really add up, and tend to rise as the size/price of your home increases.
In fact, you could easily spend $1,000 a month on these ancillary services.
So factor in all costs to ensure you don’t get in over your head, or wind up having to be your own gardener, pool guy, maid, and so on. Unless of course, that’s your thing.
*An important note to keep in mind! If you pull credit on your own or with a mortgage broker, the bank or lender you ultimately use for financing will still pull their own credit report, and any new activity will likely show up on their report.
This is why it is imperative to avoid opening any new credit cards and/or avoid making any expensive purchases on existing credit cards before and during the home-buying process.
Doing so can throw off payments and drop credit scores dramatically if you accrue a large amount of debt or open any new lines of credit between when you pull credit and the bank does.
Figure Out Your Debt-to-Income Ratio
- If you know your income and liabilities you can figure out your DTI ratio fairly easily
- Which is what lenders use to determine how much you can afford
- There are specific DTI limits depending on the loan type you apply for
- The key is to stay below these thresholds to avoid extra scrutiny or possible denial
Once you tally up all your monthly payments and divide the total by your gross monthly income, you can figure out exactly how much house you can afford by calculating your DTI, or debt to income ratio.
Banks and mortgage lenders have certain DTI ratio requirements that you cannot exceed.
As a rule of thumb, you generally want your DTI ratio at/below 43% of your monthly income.
For example, you may see something like 30/43, meaning your total monthly housing payment (mortgage payment plus property taxes and homeowners insurance) cannot exceed 30 percent of your gross monthly income.
And your housing payment plus all other monthly liabilities (including car loans/leases, student loans, credit card minimum payments, etc.) cannot exceed 43 percent of gross income.
Essentially, your annual property tax bill and total homeowners insurance premium will be divided by 12 to come up with a monthly amount that is added to your monthly principal and interest mortgage payment (known as PITI).
Make sure the mortgage calculator you use factors in these other costs, and is also accurate. Many only consider principal and interest, while underestimating or completely ignoring taxes and insurance.
Keep in mind that while the DTI is a lender requirement, you should also determine how much house you’re comfortable with financing. In other words, don’t just buy the maximum amount of house you qualify for.
For instance, you may want to sock away a certain amount of money each month for savings, retirement, or your child’s college education.
Everyone has different financial goals, so be sure to look at both the lender’s numbers and your own comfort level when determining a suitable price range to avoid winding up house poor.
Lastly, understand that the less risk you present to the lender, the lower your mortgage rate will be, which can increase your purchasing power significantly.
Simply put, a lower interest rate means a lower monthly housing payment, which will allow you to buy more house, so to speak.
To boost home purchasing power, focus on maintaining a solid credit score and keeping other monthly liabilities as low as possible.
What You’re Comfortable With vs. What Your Lender Will Allow
- Consider what your personal comfort level is first
- Regardless of what loan amount you qualify for
- Be sure to account for ALL your other monthly expenses
- Along with moving fees, renovations, utilities, and other costs associated with the home purchase
When considering mortgage affordability, you’ll need to assess both your appetite for housing costs and those of the bank or mortgage lender eventually granting you financing.
Sure, you may have some flexibility, but the lender will have well defined debt-to-income ratio requirements that will determine how much you can borrow to a T.
This precise number will be based on your gross monthly income over the past two years, not just that “big month” you had.
So take a good look at your income and your debt obligations to determine where you stand (I made a handy mortgage calculator to calculate it).
And when plugging in your loan amount, be sure to consider the entire mortgage payment, that is, principal, interest, taxes, and insurance, otherwise known as PITI.
If it’s a condo, don’t forget the HOA fees, which can amount to several hundred dollars a month and seriously change the outcome.
In short, your actual housing costs will exceed the principal and interest owed on your mortgage. So the mortgage amount you think you qualify for could be lower once these other costs are factored in.
In any case, you may not be comfortable borrowing as much as you’re able to qualify for. And that’s perfectly okay. You may want to set aside more cash each month for other things, such as investments, an emergency fund, etc.
You don’t have to borrow the maximum amount the lender approves you for. Some may even argue that you should borrow less to give yourself a cushion.
So when asking how much mortgage can I qualify for, perhaps adjust it down to compensate for all these aforementioned costs.
Picking a Certain Loan Amount to Avoid a Jumbo Mortgage
- It might be in your best interest to keep your loan amount at/below a certain threshold
- Like the conforming loan limit, which varies by county
- Or at/below a certain loan-to-value ratio (LTV)
- This may expand financing options and allow you to obtain a lower rate
If your loan amount is really large, you could wind up in the jumbo loan realm, which is currently as high as $679,650 in high-cost regions, but as low as $453,101 in cheaper areas of the country.
If you find yourself on the cusp, it might be wise to bring in a little extra down payment to qualify for a conforming loan amount, which will make financing easier to obtain and likely lead to a lower mortgage rate.
Of course, there are some aggressive jumbo lenders out there that have been known to beat conforming pricing, so it’s not necessarily a deal breaker to exceed this loan limit.
Shop Around for a Better Rate So You Can Borrow More
- If you actually take the time to shop around for a mortgage
- Which most home buyers don’t actually bother to do
- You might be able to snag a lower interest rate
- And thereby increase your home purchasing power regardless of income
Finally, shop around! While this may go without saying, if you can secure a lower mortgage rate, you’ll be able to take on a larger mortgage because it’ll be cheaper.
Don’t be one of the many consumers that only obtains a single mortgage quote. You’re simply throwing away your hard-earned money.
Check rates with your local bank, compare rates online, or enlist a mortgage broker or two to do the searching for you.
Even a difference of an eighth of a point can make a difference, so be sure not to underestimate the potential savings or costs.
In closing, just because you can afford/qualify for a mortgage doesn’t mean you should take one out. And as noted, you don’t have to borrow up your limit. You can borrow less!
With homeownership there will come unexpected costs and maintenance, so be sure to factor those in and set aside money for such occasions.
Also consider your job security – you won’t want to go nuts and buy too much house based on the expectation of future earnings, especially if you see them being at risk of falling or disappearing entirely.