Start with what you earn and what you owe

Whether you can afford a house depends on three things: how much money comes in each month, how much goes out to existing debts, and how much a lender will let you borrow. You can do this math yourself before you talk to anyone else, and you should.

Write down your gross monthly income—that is, what you earn before taxes. Include your salary, regular side income, or any other money that shows up reliably each month. If your income varies, use an average from the last two years. Then list every monthly debt payment: car loans, student loans, credit cards, child support, anything with a monthly bill. Add those up.

Lenders use a number called your debt-to-income ratio, or DTI. It is the percentage of your gross income that goes to debt payments. To find yours, divide your total monthly debt payments by your gross monthly income, then multiply by 100. If you earn $5,000 a month and pay $1,000 toward debts, your DTI is 20 percent. Most lenders want to see a DTI below 43 percent before they will lend you money for a house.

Key Takeaways

  • Your debt-to-income ratio—the percentage of your income that goes to debt payments—is the first filter lenders use, and most want it below 43 percent.
  • A down payment of 3 to 20 percent of the home price is typical, and the smaller your down payment, the more you will pay in interest and insurance over time.
  • Your monthly housing payment will include the loan itself, property taxes, homeowners insurance, and possibly mortgage insurance, and lenders usually want this total to be no more than 28 percent of your gross income.
  • Your credit score affects the interest rate you are offered, which changes your monthly payment by hundreds of dollars—checking your score before you start is worth the time.
  • Getting pre-approved for a mortgage shows you a real number you can borrow, not a guess, and costs nothing if you use a lender you trust.

How much you need to save for a down payment

A down payment is the money you put toward the house upfront. The rest comes from a mortgage loan. Down payments range from 3 percent to 20 percent of the home price, depending on the loan type and your situation.

A smaller down payment means you borrow more, which means higher monthly payments and a longer time paying interest. It also means you will pay for private mortgage insurance (PMI)—an extra monthly fee that protects the lender if you stop paying. PMI typically costs 0.5 to 1 percent of your loan amount per year, split into monthly payments. Once you own 20 percent of the home's value, you can ask to stop paying PMI.

Beyond the down payment, you also need cash for closing costs—the fees to finalize the loan. These usually run 2 to 5 percent of the home price and cover things like the appraisal, title search, and lender fees. Some sellers will pay part of your closing costs if you negotiate it into the offer, but you should assume you will cover them yourself.

What your monthly payment will actually include

Your mortgage payment is not just the loan. Lenders bundle four things into what they call PITI: principal (the loan itself), interest, taxes, and insurance.

Principal and interest are straightforward—that is what you owe the bank. Property taxes vary wildly by location; some areas charge 0.3 percent of the home value per year, others charge 2 percent or more. Your real estate agent or a tax assessor's office can tell you the rate for a specific house. Homeowners insurance covers fire, theft, and weather damage; it typically costs $800 to $2,000 per year depending on the home and your location. If you put down less than 20 percent, add PMI on top.

Lenders usually want your total housing payment—all four of these—to be no more than 28 percent of your gross monthly income. If you earn $5,000 a month, that is a maximum of $1,400 for housing. This is called your front-end ratio, and it is stricter than the overall debt-to-income ratio because housing is the biggest expense most people have.

How your credit score changes what you pay

Your credit score is a number between 300 and 850 that lenders use to decide whether to lend to you and what interest rate to charge. The higher your score, the lower your interest rate. A difference of even one percentage point on a 30-year mortgage changes your monthly payment by hundreds of dollars.

You can check your credit score for free through your bank, your credit card company, or websites like Credit Karma or AnnualCreditReport.com. If your score is below 620, most conventional lenders will not work with you; if it is between 620 and 680, you will pay a higher rate; if it is above 740, you get the best rates available.

If your score is lower than you want, you have time to improve it before you buy. Paying down credit card balances and making all payments on time for several months will raise your score. This is worth doing because a 50-point improvement can save you tens of thousands of dollars over the life of the loan.

Getting pre-approved tells you what you can actually borrow

Pre-approval is when a lender looks at your income, debts, and credit, then tells you the maximum amount they will lend you. It is not a promise to lend—the lender can still say no later if something changes—but it is a real number based on your actual finances, not a guess.

To get pre-approved, contact a bank, credit union, or mortgage lender. You will need to provide recent pay stubs, tax returns from the last two years, bank statements, and a list of your debts. The lender will pull your credit report. This takes a few days to a week. There is no cost for pre-approval if you use a lender you are genuinely considering.

Pre-approval is different from pre-qualification, which is just a rough estimate based on what you tell them over the phone. Pre-approval is the one that matters because it is based on verified information. Once you have it, you know your actual budget and can start looking at houses in that price range.

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

A lender will tell you the maximum you can borrow. That number is not the same as what you should spend. Lenders are willing to stretch because they make money from interest, not because the payment is comfortable for you.

Before you commit to a house payment, think about what else you need money for: saving for emergencies, retirement, your kids' education, car repairs, medical bills. If the maximum mortgage payment leaves you with almost nothing else, you are borrowing too much. A common rule is to spend no more than 25 to 28 percent of your gross income on housing, even if a lender will let you go higher.

Also consider the hidden costs of homeownership. Property taxes can go up. Homeowners insurance rates increase. Repairs and maintenance—a new roof, a water heater, foundation work—are your responsibility now, not your landlord's. A house that costs $1,400 a month in mortgage, taxes, and insurance might cost $1,600 or $1,700 once you factor in maintenance and repairs. Budget for that before you buy.

What to do if the answer is not yet

If the math shows you cannot afford a house right now, you have concrete steps to take. Lower your debt-to-income ratio by paying down credit cards or car loans before you apply. Save a larger down payment so you borrow less and avoid PMI. Improve your credit score by paying bills on time and reducing balances. Increase your income if possible. Or wait a year or two while you do these things.

None of these is fast, but all of them make a real difference. Paying off a $5,000 credit card balance lowers your monthly debt payments by $100 or more, which might be enough to get you under the 43 percent DTI threshold. A 50-point credit score improvement can lower your interest rate by 0.5 percent, saving you $50 to $100 a month. A larger down payment means a smaller loan and a lower monthly payment. These changes compound.

Frequently Asked Questions

What if my income is irregular or I am self-employed?

Lenders typically average your income over the last two years using tax returns. If you are self-employed, they will ask for your last two years of tax returns and possibly a profit-and-loss statement. If your income is growing, they may use only the most recent year. Be honest about what you actually earn—lenders verify this information.

Does getting pre-approved hurt my credit score?

A pre-approval involves a hard credit inquiry, which lowers your score by a few points. However, multiple mortgage inquiries within 14 to 45 days (depending on the scoring model) count as one inquiry, so shopping around with different lenders in a short window does not hurt you multiple times. The impact is temporary and usually recovers within a few months.

Can I afford a house if I have student loans?

Yes, but student loans count toward your debt-to-income ratio. If you are on an income-driven repayment plan, lenders use your actual monthly payment. If you are on the standard plan, they may use a calculated payment based on your balance. Either way, the payment reduces how much house you can afford. Paying down student loans before you buy increases your borrowing power.

What if I have a co-signer or a spouse with separate income?

If you are married or have a co-signer, lenders can combine your incomes and debts. This can help you may have access to for a larger loan if your co-signer has good credit and low debt. However, both of you are legally responsible for the loan, so make sure you both understand the commitment.

Should I get pre-approved before I start looking at houses?

Yes. Pre-approval tells you your real budget, and it shows sellers that you are serious when you make an offer. Without it, you might fall in love with a house you cannot actually afford, or waste time looking at homes outside your range. Get pre-approved first, then look.