The price you can afford depends on your down payment, income, and debt

The most expensive house you can afford is not the most expensive house a bank will lend you money for. A lender will approve you based on formulas that look at your income and existing debt. But approval and affordability are different things. You can be approved for a mortgage that leaves you house-poor—unable to pay other bills, save for emergencies, or handle a job loss.

The real number depends on three concrete things: how much cash you have for a down payment, how much you earn each month, and how much you already owe on credit cards, car loans, and student loans. This section walks through how each one works.

Key Takeaways

  • Most lenders will approve you for a mortgage if your monthly housing payment is no more than 28 percent of your gross monthly income, but many financial advisors suggest keeping it closer to 25 percent to leave room for other expenses.
  • Your down payment size directly affects the price range you can afford—a 20 percent down payment on a $300,000 house is $60,000, while a 3 percent down payment is $9,000.
  • Existing debt (car loans, credit cards, student loans) reduces how much a lender will approve you for, because lenders look at your total monthly debt payments, not just housing.
  • The price you are approved for and the price you can comfortably afford are often different—being approved for $400,000 does not mean you should spend $400,000.

How lenders calculate what you can borrow

Lenders use two main ratios to decide how much to lend you. The first is called the front-end ratio or housing ratio. It compares your monthly housing payment (mortgage, property taxes, homeowners insurance, and mortgage insurance if you put down less than 20 percent) to your gross monthly income—the money you earn before taxes.

Most lenders will approve you if your housing payment is 28 percent of your gross income or less. Some will go to 31 percent if you have strong credit and savings. So if you earn $5,000 gross per month, a lender will typically approve a housing payment of up to $1,400 per month (28 percent of $5,000).

The second ratio is called the back-end ratio or debt-to-income ratio. This one includes all your monthly debt payments—your mortgage, car loans, credit cards, student loans, and any other regular payments you owe. Most lenders want this total to be no more than 36 percent of your gross income, though some go to 43 percent.

If you earn $5,000 gross per month and already pay $600 per month on a car loan and student loans, a lender will typically approve a mortgage payment of no more than $1,200 per month (36 percent of $5,000 minus the $600 you already owe). This is lower than the 28 percent housing-only limit, so your existing debt directly shrinks the house price you can afford.

What your down payment size means for price range

Your down payment is the cash you put toward the house upfront. The rest comes from the mortgage loan. A larger down payment means you borrow less, which means a lower monthly payment—and therefore a higher total price you can afford within your income limits.

Say you can afford a $1,200 monthly mortgage payment. With a 3 percent down payment, you might be able to buy a $200,000 house (borrowing $194,000). With a 20 percent down payment, you could buy a $300,000 house (borrowing $240,000), because you are borrowing less per dollar of purchase price. The monthly payment stays the same, but the house costs more.

Down payments also affect whether you pay mortgage insurance. If you put down less than 20 percent, lenders require you to buy private mortgage insurance (PMI). This is an extra monthly fee—usually 0.5 to 1 percent of the loan amount per year—that protects the lender if you stop paying. PMI adds to your monthly payment and makes expensive houses less affordable. Once you have paid down your loan to 80 percent of the home's value, you can usually cancel PMI.

How existing debt reduces your buying power

Every monthly payment you already make—car loan, credit card minimum, student loan—counts against you when a lender decides how much house you can afford. This is because lenders look at your total monthly obligations, not just housing.

If you earn $6,000 gross per month and want to stay within a 36 percent debt-to-income ratio, you can have $2,160 in total monthly debt payments. If you already pay $800 per month on other debts, you have only $1,360 left for a mortgage payment. If you had no other debt, you could afford $2,160. That difference—$800 per month—could mean you can afford a house that is $100,000 to $150,000 cheaper, depending on interest rates.

This is why paying down credit cards or car loans before buying a house can meaningfully increase the price range you can afford. Even paying off a $300-per-month car loan before applying for a mortgage gives you more borrowing power.

The difference between approval and comfort

A lender will approve you based on the ratios above. But approval is not the same as affordability. A lender cares whether you will default on the mortgage. They do not care whether you can pay your electric bill or save for emergencies.

Many financial advisors suggest keeping your housing payment to 25 percent of gross income instead of the 28 percent lenders allow. This leaves more room for property taxes, insurance, maintenance, utilities, food, and savings. A house that uses 28 percent of your income leaves less cushion if you get a smaller paycheck, face a medical bill, or need to replace a furnace.

Use the lender's approval number as a ceiling, not a target. If a lender approves you for $450,000, that does not mean you should spend $450,000. Spend what leaves you comfortable after all other expenses and savings goals are covered.

How interest rates affect what you can afford

Interest rates change the monthly payment on the same loan amount. When rates are lower, your monthly payment is lower, so you can afford a more expensive house within your income limit. When rates are higher, your monthly payment is higher, so the same income supports a lower house price.

A $300,000 mortgage at 3 percent interest costs roughly $1,265 per month (principal and interest only). The same $300,000 at 7 percent interest costs roughly $1,996 per month. That $731 difference means that at 7 percent, you might only be able to afford a $225,000 house and stay within your 28 percent housing ratio.

Interest rates are set by the market and change daily. You cannot control them, but you should know that the house price you can afford today may not be the price you could afford if rates drop—or if they rise further. Get a pre-approval letter from a lender to see what rate they will offer you, because that rate is what determines your real buying power.

A practical example: putting the pieces together

Here is how these pieces work together in a real situation. Say you earn $4,500 gross per month, have $8,000 saved for a down payment, and pay $250 per month on a student loan.

Your lender will approve a housing payment of up to $1,260 per month (28 percent of $4,500). But your back-end ratio limits you to $1,620 total debt per month (36 percent of $4,500). Subtract your $250 student loan payment, and you have $1,370 left for housing. The lower number—$1,260—is your limit.

At current interest rates (assume 6.5 percent), a $1,260 monthly payment supports a loan of roughly $210,000. Add your $8,000 down payment, and you can afford a house priced around $218,000. If you paid off the student loan first, your limit would be $1,620, supporting a loan of roughly $270,000 and a house price around $278,000—a difference of $60,000.

Frequently Asked Questions

What if I have no down payment saved?

Some loan programs allow down payments as low as 0 to 3 percent. With 0 percent down, you borrow the full purchase price, and your monthly payment is higher. You will also pay mortgage insurance, which adds to your monthly cost. This means you can afford a less expensive house than someone with a 20 percent down payment, even at the same income level.

Does my credit score affect how much I can borrow?

Yes. A higher credit score usually means a lower interest rate, which lowers your monthly payment and lets you afford a more expensive house. A lower credit score means a higher interest rate and a higher monthly payment. Some lenders will not lend to you at all if your score is below a certain threshold, usually around 580 to 620.

Can I afford a house if I am self-employed?

Yes, but lenders verify your income differently. Instead of looking at recent pay stubs, they usually ask for two years of tax returns and may average your income over that time. If your income varies a lot, lenders may use a lower number than your most recent year earned. This can reduce how much they will approve you for.

What if I want to spend less than what I am approved for?

That is a smart choice. Spending less than your approval amount gives you breathing room for emergencies, job changes, and life expenses. A house that costs 20 to 25 percent of your gross income is often more comfortable than one at 28 percent, even if you are approved for the higher amount.

How do property taxes and insurance affect affordability?

Property taxes and homeowners insurance are part of your monthly housing payment, so they directly affect how much house you can afford. A house in an area with high property taxes or high insurance rates will have a higher monthly payment than the same house in a lower-tax area. This means you may be able to afford a less expensive house in a high-tax area, even at the same income level.