Even if you have your heart set on a certain location or type of property when you begin house hunting, your budget plays a big part in deciding which home you end up with. That’s why it’s important to know the answer to this question: “How much house can I afford?”

At the same time, income is just one piece of the puzzle when it comes to buying a home and getting a mortgage. There are many factors that will affect whether you’re approved, and for how much — including your debt-to-income ratio, down payment, credit score, and more.

Key Factors That Affect the Mortgage You Can Afford

There are a handful of major factors that influence whether you’ll be approved for a mortgage, and at what interest rate and terms.

Debt-to-income ratio

To evaluate your ability to repay a mortgage, lenders will calculate your debt-to-income ratio, which measures how much of your gross monthly income goes toward paying debt obligations. A DTI ratio that’s too high could be a sign that you’re overextended financially and can’t afford to take on another loan.

To calculate your DTI ratio, divide your total monthly debt payments by your gross monthly income, then convert the result to a percentage. For example, say you have credit card, car loan, and student loan payments that total $1,200 per month, and you earn $5,500 per month before taxes. Divide $1,200 by $5,500 to get 0.22. Multiply 0.22 by 100 for a DTI ratio of 22%.

When the projected mortgage payment — meaning your principal, interest, taxes, and insurance — and all your debts are included in the calculation, it’s referred to as your back-end ratio. Lenders also look at your front-end ratio, which considers only the mortgage payment in relation to your income.

The 28/36 rule

The maximum allowable DTI ratio can vary. However, lenders generally follow the 28/36 rule.

“This rule of thumb is used to calculate exactly how much you can afford to spend on monthly mortgage payments, while keeping in mind all other costs associated with owning a home,” says Daniela Andreevska, vice president of content and real estate consultant at Mashvisor, a real estate data analysis platform based in Campbell, California.

According to the 28/36 rule, you shouldn’t spend more than 28% of your gross monthly income on your mortgage, and your total debt payments shouldn’t exceed 36%. In other words, the maximum front-end ratio is 28%, and the maximum back-end ratio is 36%.

How to improve your DTI ratio

If your DTI ratio is too high to qualify for a mortgage, there are two approaches you can take to improve it:

  • Reduce your existing debt. For example, you could work on paying off a credit card balance. This would lower your total monthly debt payments.
  • Increase your income. If you successfully ask for a raise at work or take on a side hustle, your earnings would increase relative to your debt payments.

Down payment

Your down payment has a significant impact on the cost of your mortgage. The more you put down, the less you need to borrow, which means smaller monthly payments and less interest paid over the life of the loan.

It’s also less risky to extend a loan to a borrower who’s putting more money down, since they have a greater stake in the home they’re buying. That’s why lenders usually offer lower interest rates to borrowers making a larger down payment.

Of course, saving for a down payment takes time. It’s also not necessary to make a 20% down payment.

“Contrary to popular belief, it is a myth that it is required to put 20% down to purchase a home,” says Shelby McDaniels, channel director of corporate home lending at Chase in Columbus, Ohio.

Some types of mortgages may require far less of a down payment. For conventional loans, which are the most common loan type, qualified borrowers can put down as little as 3%.

However, if you put less than 20% down with a conventional mortgage, you must pay for private mortgage insurance until you reach 20% equity in the property — adding to your loan costs.

Credit score

In addition to helping you qualify for a mortgage, your credit score affects the interest rate on the loan. Higher credit scores generally correspond to lower mortgage rates.

“If your credit scores are high, it tells lenders that you have paid your credit card bills on time and that you are responsible with your money,” McDaniels says. On the other hand, a low credit score could signal that you’ve had trouble repaying debts in the past.

For a conventional mortgage, you’ll need a credit score of at least 620. To get the best terms, however, higher is better.

“Ultimately, any score in the 700s or above is considered good and will help you get a loan with a lower interest rate,” McDaniels says.

How to improve your credit score

If your credit score isn’t where you want it to be, there are several ways to help improve your score:

  • Pay all your bills on time. Payment history is the most heavily weighted category, making up 35% of your credit score. One of the best things you can do to build good credit is making all your payments on time and in full.
  • Pay down debt. Improving your DTI ratio is also good for your credit score. The amounts you owe make up 30% of your score, so decreasing your outstanding debt can boost your credit.
  • Avoid new credit applications. Whenever you apply for a loan or credit card, the lender reviews your credit file. This results in what’s known as a “hard inquiry,” which can hurt your score. A new account also decreases the average length of your credit history — another potentially negative mark.

Other important factors to consider

There are other factors to consider when evaluating the cost of a home loan, including the mortgage rate, interest rate type, and loan term:

  • The interest rate you pay on your mortgage can make a huge difference in its affordability. A difference of a fraction of a percentage point can mean spending or saving up to thousands of dollars over the life of the loan.
  • There are two basic types of interest rates: fixed and adjustable. Adjustable-rate mortgages can start off with lower interest rates compared to fixed-rate mortgages, but they change over time, so your payments will fluctuate with an ARM. On the other hand, payments for a fixed-rate mortgage remain the same over the life of the loan.
  • A couple of the most popular loan terms are 15-year and 30-year mortgages. A longer loan term translates to a lower monthly payment. However, the trade-off is that you’ll spend more on interest overall.  

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How Much Mortgage Can You Qualify For?

Using a home affordability calculator can be helpful when you’re trying to figure out the answer to this question: “How much house do I qualify for?” Enter details such as your annual gross income, monthly debt payments, down payment, and more to get an estimate of how much you can afford to spend. Find out what you might be able to afford on a $35,000, $75,000, or $120,000 salary by crunching the numbers.

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Costs Beyond the Monthly Mortgage Payment

Though the mortgage has a big impact on whether you can afford a home, it’s not the only cost to consider. You’ll also need to pay closing costs, which are a lump sum equal to about 2% to 5% of the loan amount. Plus, there are many expenses associated with owning a home.

“Many of these are costs that you would not have to worry about should you choose to continue renting rather than buying a home,” Andreevska says.

For example, owners are responsible for paying property taxes and homeowners insurance. They also need to budget for maintenance, repairs, and potentially homeowners association fees, depending on the type of home.

“If you used to rent, these are costs that were most probably covered by the landlord,” Andreevska says. “Now, as a homeowner, you will have to account for them when budgeting how much you can afford to spend on housing.”

Depending on your rental agreement, you may have some or all your utility costs covered by the property owner. As a homeowner, you would foot the bill for these expenses, including electricity, gas, and water.

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Understanding the Different Loan Options

The type of loan you choose affects the affordability of your mortgage. Some loan types also make it easier for certain homebuyers to qualify, including first-time buyers. Below is a closer look at the different loan options.

Conventional loans

A conventional mortgage is a home loan that’s not part of any government program. A down payment of 20% is required to avoid PMI, though some lenders allow borrowers to put down as little as 3%. Borrowers typically need a credit score of at least 620 to qualify, and their DTI ratio shouldn’t exceed 50% for loans underwritten through an automated system. For manually underwritten loans, the maximum DTI ratio is 36% to 45%, depending on the borrower’s situation.

Jumbo loans

Conventional mortgages are subject to conforming loan limits. For 2022, the maximum loan amount for a single-unit home is $647,200, or $970,800 in certain areas with a high cost of living. Loans that exceed these limits are considered nonconforming jumbo loans.

Due to their size, these jumbo loans are considered riskier for lenders, and often come with stricter requirements. Many lenders require a credit score of at least 720, along with a down payment of 20% to 30%.

FHA loans

Loans insured by the Federal Housing Administration have relaxed qualifications compared with conventional mortgages. The minimum down payment depends on the borrower’s credit score. Borrowers with a score of at least 580 can put down as little as 3.5%, while borrowers with scores between 500 and 579 must put down at least 10%. The maximum back-end DTI ratio for FHA loans is 43%.

FHA borrowers also need to pay annual mortgage insurance premiums, which are calculated based on their down payment and the loan balance.

VA loans

Loans insured by Veterans Affairs are available to eligible service members, veterans, and surviving spouses. Qualified borrowers can put zero down, and there’s no official credit score requirement, though lenders may impose their own minimums. Generally, the maximum back-end DTI ratio for VA loans is 41%.

There’s also a one-time VA funding fee. For first-time VA borrowers, the fee is 1.65% to 2.3% of the loan amount.

USDA loans

Loans insured by the Department of Agriculture help low-income borrowers afford housing in eligible rural areas. There’s typically no down payment required, and the recommended minimum credit score is 640, though the USDA doesn’t set a requirement. The maximum back-end DTI ratio for USDA loans is 41%, or 44% for borrowers with a score of at least 680.

USDA borrowers also need to pay an upfront guarantee fee of up to 3.5% of the loan amount, and an annual fee of up to 0.5% of the mortgage balance.

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When To Keep Renting Instead of Buying a Home

Homeownership can be a path to building wealth, but buying a home isn’t always the right move. It could make more sense financially to keep renting vs. buying a home if you live in a market with a high price-to-rent ratio, according to Andreevska. The price-to-rent ratio is the median home price in a market divided by the median annual rent in the same market.

“If the price-to-rent ratio exceeds 20, it means that home values are high compared to rental rates, so you are probably better off from a financial point of view if you rent and abstain from buying,” Andreevska says.

Another situation where it might make sense to continue renting for a little while is if you anticipate a positive change to your finances. For example, you could wait to buy if you’re expecting a promotion or raise at work, which will result in a higher income.

“Your higher income level will be able to provide you with more favorable mortgage terms as lenders will perceive of you as a more reliable borrower,” Andreevska says.

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The Bottom Line on Budgeting For a House

The process of buying a home starts well before attending open houses and submitting your mortgage application. There are multiple factors to consider that affect your ability to afford a home and get approved for a loan. So, before setting your sights on a particular property, spend some time crunching the numbers and deciding what the right mortgage looks like for your financial situation.