Start with what you actually have: your down payment and debt

The amount of house you can afford depends on three things: how much money you have saved for a down payment, how much you earn each month, and what debts you already owe. A lender will not give you a mortgage larger than a certain percentage of your income, and they will not lend to you if your existing debts are too high. You need to know these numbers before you talk to anyone.

Begin by adding up what you have saved. Most lenders want a down payment of at least 3 to 20 percent of the home's price, depending on the loan type. If you have $30,000 saved and put down 10 percent, you can afford a home around $300,000. If you can only put down 3 percent, that same $30,000 gets you into a $1 million home — but the lender will charge you more in interest and require you to pay mortgage insurance, which makes the monthly payment much higher.

Next, write down your gross monthly income — the money you earn before taxes. This is what lenders look at, not your take-home pay. If you earn $60,000 a year, your gross monthly income is $5,000.

Then list every debt you owe: car loans, student loans, credit cards, personal loans, anything with a monthly payment. Add up the total monthly payment amount. This number matters because lenders have a rule about how much of your income can go toward all debt payments combined.

Key Takeaways

  • Lenders typically allow your mortgage payment to be no more than 28 percent of your gross monthly income, and all your debt payments combined should not exceed 36 to 43 percent of that income.
  • Your down payment size directly affects how much house you can afford — a larger down payment means you can buy a more expensive home with the same monthly payment.
  • Existing debts like car loans and student loans reduce the amount a lender will let you borrow, even if you have a high income.
  • The interest rate you receive depends partly on your credit score, so checking your score before house hunting tells you what monthly payments will actually cost.

The debt-to-income ratio: what lenders actually use

Lenders use a number called the debt-to-income ratio to decide how much they will lend you. This is the percentage of your gross monthly income that goes toward debt payments. Most lenders will not lend to you if this ratio is above 43 percent, though some will go as high as 50 percent if your credit is very good.

Here is how to calculate it. Add up all your monthly debt payments — mortgage payment (estimated), car loan, student loans, credit cards, anything with a fixed monthly bill. Divide that total by your gross monthly income. Multiply by 100 to get a percentage.

Example: You earn $5,000 gross per month. You have a car payment of $400 and student loan payments of $200. That is $600 in existing debt. If your estimated mortgage payment is $1,400, your total debt is $2,000. Divide $2,000 by $5,000 and you get 0.40, or 40 percent. Most lenders will accept this.

Many lenders also use a stricter rule just for the mortgage payment itself: it should not exceed 28 percent of your gross monthly income. In the example above, $1,400 divided by $5,000 is 28 percent, so you are at the limit. If you want to stay comfortably under the limit, aim for a mortgage payment around 25 percent of your income.

How to estimate your actual monthly payment

The monthly mortgage payment is not just the loan amount divided by the number of months. It includes the loan payment itself, property taxes, homeowners insurance, and possibly mortgage insurance. Lenders call this PITI — Principal, Interest, Taxes, and Insurance.

The principal and interest portion depends on three things: how much you borrow, the interest rate, and how many years you take to pay it back. A $300,000 loan at 7 percent interest over 30 years costs roughly $2,000 per month in principal and interest alone. But property taxes vary wildly by location — they might add $200 to $600 per month. Homeowners insurance might add another $100 to $200 per month. If you put down less than 20 percent, you will also pay mortgage insurance, which can add $200 to $400 per month.

You can find rough estimates online using a mortgage calculator, but the numbers will not be exact until a lender actually quotes you. The interest rate you receive depends on your credit score, the size of your down payment, and current market rates. If your credit score is below 620, many lenders will not work with you at all. If it is between 620 and 740, you will pay a higher rate than someone with a score above 760.

Before you talk to a lender, pull your credit report from one of the three major bureaus — Equifax, Experian, or TransUnion — at annualcreditreport.com. This is free once per year. Check it for errors and dispute anything wrong. A higher credit score can save you tens of thousands of dollars over the life of the loan.

Working backward from a monthly payment you can afford

If you know what monthly payment fits your budget, you can work backward to find the home price. Start with the 28 percent rule: take your gross monthly income and multiply by 0.28. That is the maximum you should spend on the mortgage payment itself.

Example: You earn $5,000 gross per month. Multiply by 0.28 and you get $1,400. That is your target mortgage payment. Now subtract what you will pay in property taxes and insurance. If those total $300 per month, you have $1,100 left for principal and interest. Using an online mortgage calculator, you can see that $1,100 per month buys you roughly a $160,000 loan at 7 percent interest over 30 years. If you have $30,000 for a down payment, you can afford a home around $190,000.

This method is useful because it keeps you from overextending. Many people get approved for more than they should borrow. Just because a lender will lend you $400,000 does not mean you should take it. Your actual monthly costs — utilities, maintenance, property taxes that rise over time, insurance increases — will be higher than you expect.

Why your credit score changes what you can afford

Two people with the same income and down payment can afford very different homes if their credit scores are different. The interest rate you receive is based largely on your credit score, and even a 1 percent difference in interest rate changes your monthly payment by hundreds of dollars.

A $300,000 loan at 6 percent interest costs about $1,800 per month in principal and interest. The same loan at 7 percent costs about $2,000 per month. The same loan at 8 percent costs about $2,200 per month. Over 30 years, that 2 percent difference adds up to $144,000 in extra payments.

If your credit score is below 700, you may want to wait six months to a year before buying. During that time, pay all bills on time, pay down credit card balances, and do not open new accounts. These steps can raise your score by 50 to 100 points, which can lower your interest rate by 0.5 to 1 percent. The money you save is worth the wait.

The difference between what you can afford and what you should borrow

Lenders will often approve you for more than is wise. A lender cares about whether you can make the payment; they do not care whether you will be house-poor, unable to save, or stressed about money. That is your decision to make.

A good rule of thumb is to borrow no more than 2.5 to 3 times your gross annual income. If you earn $60,000 per year, that means borrowing no more than $150,000 to $180,000. This leaves room for emergencies, maintenance, and life changes. A home is not an investment that will make you rich — it is a place to live. Do not sacrifice your financial security to buy the biggest house a lender will approve.

Also remember that your costs will rise. Property taxes increase. Insurance premiums increase. Roofs need replacing. Furnaces break. If your mortgage payment is 28 percent of your income, your total housing costs — including taxes, insurance, and maintenance — will be closer to 35 to 40 percent. Make sure you have room in your budget for that.

Getting pre-approved and what it actually means

Once you have done the math on your own, you can get pre-approved by a lender. Pre-approval means a lender has looked at your income, debts, and credit, and told you the maximum amount they will lend. It is not a may provide — the lender will do a final check when you actually buy a home, and things can change if you lose your job or take on new debt.

Pre-approval is useful because it tells you what interest rate you might receive and confirms that you can borrow what you think you can. It also shows sellers that you are serious. But pre-approval is not the same as a final loan offer. Do not assume the terms will stay the same when you actually apply.

When you get pre-approved, ask the lender for the interest rate in writing, the estimated closing costs, and whether the rate is locked in. Some lenders offer a rate lock, which means the rate will not change for 30 to 60 days. Others do not. If rates are rising, a rate lock protects you. If rates are falling, you might want to wait.

Frequently Asked Questions

What if I have student loans or other debt I cannot pay off before buying?

Lenders count the monthly payment toward your debt-to-income ratio, not the total amount owed. If your student loan payment is $200 per month, that $200 counts against your 43 percent limit. You do not have to pay off the loan first, but the payment reduces how much house you can afford.

Does a co-signer help me afford more house?

Yes, if the co-signer has good income and low debt. Lenders add the co-signer's income to yours and count their debts too. But the co-signer is legally responsible for the loan if you cannot pay, so this is a serious commitment for them.

What if I get a raise after I buy — can I afford more house later?

You can refinance to a larger loan if your home has increased in value and your income has risen. But refinancing costs money in closing costs and takes time. Buy based on what you can afford now, not on raises you expect.

How much should I save for a down payment?

The more you save, the less you borrow and the lower your monthly payment. Twenty percent down avoids mortgage insurance and gives you the best rates. But 3 to 5 percent down is common if you cannot save more. The trade-off is a higher monthly payment and mortgage insurance costs.

Can I use gift money for my down payment?

Most lenders allow gift money from family, but they require a letter from the giver stating it is a gift, not a loan. Some lenders have limits on how much of your down payment can be a gift. Ask your lender before accepting money.