Start with what you actually earn

The most straightforward way to know how much house you can afford is to look at your gross monthly income—the money you make before taxes and deductions. Most lenders use a rule called the debt-to-income ratio, which compares your total monthly debt payments to your gross income. If you earn $5,000 a month gross and your total debts (car loans, credit cards, student loans, plus the new mortgage) would be $1,500 a month, your ratio is 30 percent.

Lenders typically want to see a debt-to-income ratio of 43 percent or lower, though some will go higher if you have strong savings or a very stable income. This means if you earn $5,000 a month, most lenders will let your total debts reach about $2,150. Subtract what you already owe on cars, credit cards, and student loans, and what's left is roughly what you can borrow for a mortgage payment.

The catch: this is what lenders will let you borrow, not what you should borrow. A lender's math assumes you want to spend the maximum allowed. Your own math should be different.

Key Takeaways

  • Your debt-to-income ratio—total monthly debt divided by gross monthly income—is the number lenders use, and most want to see 43 percent or lower.
  • A mortgage payment includes not just principal and interest, but also property taxes, homeowners insurance, and possibly mortgage insurance, so the actual monthly cost is higher than the loan payment alone.
  • The 28 percent rule (housing costs should not exceed 28 percent of gross income) is a more conservative starting point than the lender's maximum.
  • Your down payment, credit score, and existing debts all change how much a lender will offer you, so getting pre-approved shows you a real number rather than a theoretical one.
  • What you can afford and what you should afford are different questions—leaving room in your budget for emergencies and other goals matters more than borrowing the maximum.

Understand what "the mortgage payment" actually includes

When a lender quotes you a monthly mortgage payment, they are usually talking about principal and interest only—the money that goes toward paying down the loan itself. But your actual monthly housing cost is much larger. You also pay property taxes, homeowners insurance, and possibly private mortgage insurance (PMI) if your down payment is less than 20 percent.

Property taxes vary wildly by location. In some counties they run 0.3 percent of the home's value per year; in others they run 2 percent or more. A $300,000 house in a low-tax area might cost $750 a month in property tax, while the same house in a high-tax area might cost $5,000 a month. You need to know your local rate before you do any math.

Homeowners insurance typically runs $100 to $300 a month depending on the home's value, age, and location. Mortgage insurance (PMI) adds another $100 to $300 a month if you put down less than 20 percent. So a $1,500 principal-and-interest payment might actually cost you $2,200 or $2,300 once you add taxes, insurance, and PMI. If you only budgeted for $1,500, you will be short every month.

Use the 28 percent rule as your personal ceiling

Lenders use the 43 percent debt-to-income ratio because they are comfortable with risk. You should not be. A better personal rule is the 28 percent rule: your total housing costs (mortgage payment, property taxes, insurance, and PMI) should not exceed 28 percent of your gross monthly income.

If you earn $5,000 a month gross, 28 percent is $1,400. That is your total housing budget—everything combined. This leaves room for the other 72 percent to cover food, transportation, utilities, childcare, medical costs, and savings. It also leaves a cushion if you lose income, face a major repair, or encounter an unexpected expense.

The 28 percent rule is more conservative than what lenders will offer, and that is the point. It keeps you from stretching so far that one setback—a job loss, a medical bill, a major home repair—forces you to choose between the mortgage and other necessities.

Get pre-approved to see what lenders will actually offer

Calculating what you can afford on paper is useful, but a pre-approval letter from a lender shows you a real number based on your actual finances. To get pre-approved, you will need to provide recent pay stubs, tax returns (usually the last two years), bank statements, and a list of your debts. The lender will pull your credit report and run the numbers.

Pre-approval is not the same as a final loan offer. It means the lender has reviewed your finances and is willing to lend you up to a certain amount, assuming the home you choose appraises at the expected value and nothing major changes in your finances before closing. It is a snapshot, not a may provide.

The pre-approval amount is useful because it shows you what lenders think you can borrow given your income, debts, savings, and credit score. But again: what they will lend you is not the same as what you should borrow. If the pre-approval is for $450,000 and the 28 percent rule suggests you should spend $350,000, the 28 percent number is the one to follow.

Account for your down payment and closing costs

How much you can borrow depends partly on how much you have saved for a down payment. A larger down payment means you borrow less, which means a smaller monthly payment. It also means you avoid PMI if you put down 20 percent or more.

Down payments typically range from 3 percent to 20 percent of the home's purchase price. A 3 percent down payment on a $300,000 house is $9,000; a 20 percent down payment is $60,000. The difference in monthly payment is substantial. On a $291,000 loan (after 3 percent down), the principal-and-interest payment might be $1,700; on a $240,000 loan (after 20 percent down), it might be $1,400.

Do not forget closing costs, which typically run 2 to 5 percent of the purchase price. These are fees for the appraisal, title search, underwriting, and other services required to close the loan. On a $300,000 purchase, closing costs might be $6,000 to $15,000. Some buyers roll these into the loan; others pay them upfront. Either way, you need to have the money available.

Factor in your other debts and financial obligations

The debt-to-income ratio matters because a large mortgage payment is not your only monthly obligation. If you have a car loan, student loans, credit card payments, or child support, those all count toward your total debt. A lender will add them all together and compare the total to your income.

If you earn $5,000 a month and already owe $800 a month on a car loan and $300 a month on student loans, you have $1,100 in existing debt. If the lender's 43 percent threshold allows $2,150 in total debt, that leaves only $1,050 for a mortgage payment. That is a much smaller loan than someone with no existing debt could take.

Before you start house hunting, pay down high-interest debt if you can. Paying off a car loan or credit card balance before you apply for a mortgage can free up hundreds of dollars a month in borrowing power. It also improves your credit score, which can lower your interest rate.

Know how your credit score affects what you can borrow

Your credit score influences both whether a lender will work with you and what interest rate they will offer. A score of 740 or higher typically qualifies for the best rates; a score between 620 and 680 will still get you a loan but at a higher rate; a score below 620 is much harder to work with.

The difference in interest rate can be substantial. On a $300,000 loan, a 6.5 percent interest rate costs roughly $1,896 a month in principal and interest. A 7.5 percent rate costs roughly $2,098 a month—$200 more every month, or $72,000 more over the life of a 30-year loan. If your credit score is lower than you would like, spending a few months paying bills on time and paying down balances can raise it and save you real money.

Frequently Asked Questions

What if I have irregular income or I am self-employed?

Lenders typically average your income over two years if you are self-employed or have variable income. You will need to provide tax returns and possibly profit-and-loss statements. Some lenders are stricter about this than others, so shop around. You may also need a larger down payment or a higher credit score to offset the income uncertainty.

Can I afford a house if I have student loan debt?

Yes, but it reduces how much you can borrow. Student loans count toward your debt-to-income ratio just like any other debt. If you have $30,000 in student loans with a $300 monthly payment, that $300 reduces your available mortgage budget. Paying down the loans before you buy will increase your borrowing power.

What happens if I get a raise after I buy?

A raise does not change your mortgage payment, which is locked in when you close the loan. It does give you more breathing room in your budget for other expenses, savings, or home maintenance. This is another reason to avoid borrowing the absolute maximum—future raises should improve your financial security, not just let you maintain the same tight budget.

Should I use an online calculator or talk to a lender?

Online calculators are useful for rough estimates, but a lender's pre-approval is more accurate because it accounts for your specific credit score, debts, and down payment. Use a calculator to get a ballpark figure, then get pre-approved to see what you actually may have access to for. The two numbers may be different.

What if the house I want costs more than I can afford?

Look for a less expensive home, save a larger down payment, or wait until you have paid down other debts or increased your income. Stretching beyond what the 28 percent rule suggests is how people end up house-poor—paying so much for housing that they cannot afford maintenance, emergencies, or anything else. A smaller house you can comfortably afford is better than a larger one that consumes your entire budget.