What buying power means and why it matters
Buying power is the total amount of money you can spend right now—cash on hand plus money you can borrow. It is not the same as your income or your savings account balance. A person earning $30,000 a year might have $50,000 in buying power if they have savings and access to credit. Another person earning $100,000 might have only $15,000 if they have no savings and lenders won't give them a loan.
Knowing your buying power before you shop for a house, a car, or anything else you need to finance prevents you from falling in love with something you cannot actually afford. It also tells you what price range to focus on, so you do not waste time looking at homes or vehicles outside what you can actually get approved for.
Buying power depends on three things: the cash you have right now, the money lenders think you can borrow, and the interest rate they will charge you. This article walks you through calculating each one.
Key Takeaways
- Buying power is your cash on hand plus the maximum amount a lender will loan you, not your annual income.
- Lenders look at your debt-to-income ratio—the percentage of your monthly income that goes to debt payments—to decide how much they will lend you.
- Your credit score affects both the amount a lender will give you and the interest rate they charge, which changes your monthly payment and total buying power.
- A down payment reduces the amount you need to borrow, so saving more cash increases your buying power for the same monthly payment.
- The interest rate and loan term (how many years you have to pay it back) change your monthly payment, which determines how much you can borrow.
Step 1: Add up the cash you have available right now
Start with money you can actually spend without breaking your life. This includes a savings account, a money market account, or cash in hand. Do not count money you need for emergencies or money that is already promised to something else.
For a house purchase, most lenders want you to keep a cash reserve after you make the down payment—usually three to six months of your new mortgage payment plus property taxes and insurance. So if your new payment will be $1,500 a month, you should keep $4,500 to $9,000 in reserve. Subtract that from your total savings to find the amount you can actually use as a down payment.
For a car, the math is simpler: the cash you have is the cash you can put down. There is no standard reserve requirement, but keeping $1,000 to $2,000 for unexpected repairs is common sense.
Step 2: Calculate your debt-to-income ratio
This is the number lenders use most often to decide how much they will lend you. Debt-to-income ratio is the percentage of your gross monthly income (before taxes) that goes to debt payments each month.
To calculate it, add up all your monthly debt payments: car loans, student loans, credit card minimum payments, child support, alimony, and any other loan payments. Do not include rent or utilities. Divide that total by your gross monthly income, then multiply by 100 to get a percentage.
For example: If you earn $4,000 gross per month and your current debt payments total $800 per month, your debt-to-income ratio is 20 percent ($800 ÷ $4,000 × 100 = 20%). Most mortgage lenders will lend you money if your ratio stays below 43 percent, though some go as high as 50 percent. Auto lenders are often more flexible, sometimes accepting ratios up to 60 percent.
When you add a new loan payment, your ratio goes up. A lender will calculate what your ratio would be after they give you the loan, and they will only lend you an amount that keeps you below their limit.
Step 3: Find out how much a lender will give you
The amount a lender will loan you depends on your debt-to-income ratio, your credit score, the interest rate they offer you, and the loan term (how many years you have to pay it back).
For a mortgage, use this rough calculation: Take your gross monthly income, multiply it by 0.43 (the 43 percent debt-to-income limit), and subtract your current monthly debt payments. The result is the maximum new monthly payment a lender will give you. Then use a mortgage calculator—available free from most banks' websites—to convert that monthly payment into a loan amount. The calculator asks for the interest rate and loan term, which change the answer.
For a car loan, the math is similar but the limits are looser. Many auto lenders will lend you up to 50 percent of your gross monthly income, though they also look at your credit score and whether you have a down payment. A car loan calculator on a bank or credit union website will show you the loan amount based on the monthly payment you can afford.
Your credit score affects both the loan amount and the interest rate. A higher score usually means a lower interest rate, which means a lower monthly payment, which means you can borrow more money for the same payment. A lower score means a higher interest rate and a higher monthly payment, which means you can borrow less.
Step 4: Add your down payment to the loan amount
Once you know how much a lender will loan you, add your down payment to find your total buying power.
Example: You have $30,000 saved for a down payment on a house. A lender will give you a mortgage of $280,000 based on your income and debt. Your buying power is $310,000 ($30,000 + $280,000).
If you increase your down payment, your buying power goes up by the same amount, because you are borrowing less. If you save another $20,000 and put down $50,000 instead, your buying power becomes $330,000 (assuming the lender still gives you $280,000).
How interest rates and loan terms change your buying power
The interest rate and the loan term work together to set your monthly payment. A lower interest rate or a longer loan term means a lower monthly payment, which means you can borrow more money without exceeding your debt-to-income limit.
Example: A $300,000 mortgage at 6 percent interest over 30 years costs about $1,799 per month. The same $300,000 at 7 percent interest costs about $1,996 per month—$197 more. If your debt-to-income limit allows a $1,799 payment, you can borrow $300,000 at 6 percent. But at 7 percent, your payment would exceed your limit, so the lender would only give you about $270,000.
Interest rates change based on market conditions and your credit score. You cannot control the market, but you can improve your credit score by paying bills on time and keeping credit card balances low. Even a small improvement in your score can lower your interest rate by 0.25 to 0.5 percent, which adds up over the life of a loan.
What changes your buying power over time
Your buying power is not fixed. It changes when your income changes, when you pay off debt, or when your credit score changes.
If you get a raise, your gross monthly income goes up, which increases the amount you can borrow without exceeding your debt-to-income limit. If you pay off a car loan or credit card, your monthly debt payments go down, which also increases your borrowing capacity. If you improve your credit score by paying bills on time, lenders may offer you a lower interest rate, which lowers your monthly payment and lets you borrow more.
The opposite is also true. A job loss, a new debt, or a drop in your credit score all reduce your buying power. This is why it is worth checking your buying power several times before you make a major purchase—your situation may have changed since the last time you looked.
Frequently Asked Questions
Does my buying power include money I owe on credit cards?
No. Your buying power is what you can spend, not what you owe. But credit card debt counts against you when a lender calculates your debt-to-income ratio. If you owe $5,000 on a credit card with a minimum payment of $150 per month, that $150 reduces the amount a lender will give you for a new loan.
What if I have no credit score or a very low one?
Lenders may still work with you, but they will charge a higher interest rate and may require a larger down payment. Some credit unions and community banks are more flexible than national banks. Your buying power will be lower than someone with a good credit score, but it is not zero. Building credit by getting a secured credit card or becoming an authorized user on someone else's account takes time but increases your options.
Does my buying power change if I get married?
Yes. If you apply for a loan together, the lender looks at both of your incomes and both of your debts. Your combined buying power is usually higher than either of you alone, but it also depends on whether you combine your debts or keep them separate. Talk to a lender about how they calculate it for your situation.
Can I increase my buying power by paying off debt before I apply for a loan?
Yes. Paying off a car loan, student loan, or credit card lowers your monthly debt payments, which lowers your debt-to-income ratio. This lets a lender give you a larger loan for the same monthly payment. Paying off debt also usually improves your credit score over time, which can lower your interest rate.
Is buying power the same as pre-approval?
No. Buying power is an estimate based on your income, debts, and credit score. Pre-approval is a formal offer from a lender that says they will lend you a specific amount at a specific interest rate, based on a full application and credit check. Pre-approval is more reliable than a buying power estimate, but it is also more work to get.