If you are a W2 employee of a company, you can prove your income via your pay stubs and tax returns. Self-employed borrowers may be asked to show their personal and business tax returns, bank statements, and profit and loss statements. You can also qualify using Social Security income, disability benefits, alimony, and child support. Your lender will tell you which documents you must submit to verify your income.
Down payments directly impact mortgage affordability. The bigger your down payment, the less you need to borrow, and therefore the smaller your mortgage payment for the home.
Let's say you're buying a $300,000 home with a 30-year mortgage:
||Monthly principal + interest due**
**The monthly payments shown here do not include additional fees such as homeowners insurance, property taxes, or PMI on conventional loans. Payments are for example purposes only. Not based on currently available rates. With 20% or more down on a conventional loan, you wouldn't pay any PMI.
A sizeable down payment can also help you qualify for a lower interest rate. That's because the lender takes on less risk when you put more down upfront. Lenders can reward borrowers with more competitive rates to incentivize them to put down more.
The good news is the down payment doesn't necessarily have to come from your savings. Some loan programs allow you to use gift funds toward the down payment, so friends and family can help you get into the home at a potentially lower rate and monthly payment.
Your debt-to-income ratio is another crucial element lenders consider when you apply for a loan. The DTI tells them how much of your monthly income goes into debt already and how much they'll realistically have to put toward a housing payment.
Here's how to calculate your DTI:
- Add up your minimum monthly installments for your credit card payments, car loans, student loans, personal loans, and other debts (Don't include your utility payments, grocery bill, or rent.)
- Divide your debts by your gross monthly income (your income before taxes)
- That's your DTI.
So, someone who earns $5,000 a month and pays $2,000 a month toward debts has a DTI of 40%.
Like your income, DTI affects your eligibility for different loan programs. Conventional loans typically require a DTI of 45% or less, whereas FHA loans may be available to borrowers with DTIs of 50% or higher. Your lender will be able to tell you which loan options are on the table when you get preapproved.
Your mortgage loan's term - or the repayment period - is a huge factor in the size of your monthly payment. Let's take a look at a $300,000 house with a down payment of 5%:
||Principal + Interest payment
||Total interest paid over the life of the loan
***The monthly payments shown here do not include additional fees such as homeowners insurance, property taxes, or PMI on conventional loans. Payments are for example purposes only. Not based on currently available rates.
As you can see, a longer term lowers the monthly house payment, which means you might be able to fit a more expensive home into your monthly budget.
But notice the catch: Stretching out the debt for 30 years means you'll pay much more interest over the life of your loan. On top of that, shorter loan terms often come with lower interest rates, which means you could save even more with a shorter term than this chart shows.
If you'd prefer to start out with a lower payment now but your income increases in a few years, you can refinance into a shorter-term loan later. You will pay closing costs on the new loan, so you'd want to ensure the savings were worth it and that the new payment is affordable. But opting for a 30-year mortgage can get you into a home, and you can reevaluate your position later.
Let's return once again to that $300,000 home with a 5% down payment and a 30-year loan term to see how the interest rate affects the cost of the home. Each row represents a half-percent increase in the rate:
|Total interest over the life of the loan
The monthly payments shown here do not include additional fees such as homeowners insurance, property taxes, or PMI on conventional loans. Payments are for example purposes only. Not based on currently available rates. With 20% or more down on a conventional loan, you wouldn't pay any PMI.
As you can see, a 2% increase in your interest rate adds more than $300 to your house payment and almost $120,000 to the total loan cost over 30 years.
Getting a lower rate can also open the doors to more expensive homes since your lender may be able to approve you for a higher loan amount.
But, you may be thinking, you can't control your interest rate. This is only partly true. Market conditions set the context for the rate you'll get. (Rates have been quite low over the past year as the economy navigates the coronavirus pandemic.)
But you still have a lot of influence over the actual rate you can lock in because your personal financial profile comes into play as well. Here's how you can help yourself get a better mortgage rate:
- Improve your credit score: Paying down your existing debts and making on-time payments can raise your score and put you in a range of low rates
- Lower your DTI: A low DTI represents less risk to your lender and may qualify you for better rates
- Pick a shorter term, if possible: Shorter terms, such as a 15-year mortgage, tend to offer lower rates than 30-year loans. But do this only if you can afford the higher principal and interest payment that comes from a shorter-term loan.
- Make a bigger down payment: The more you can put down, the better your chances of accessing lower rates.
- Get the right loan type: Loan types matter. For example, FHA loans work well for credit-challenged homebuyers, and they tend to have low rates because they're government-backed. But if you have a stellar credit profile, a conventional loan could be your best bet with a competitive rate and the other benefits of conventional loans.
- Buy discount points: Discount points allow you to lower your interest rate by paying an upfront fee. A discount point typically costs 1% of your loan amount and drops your rate by 0.25%. This can pay off if you plan to stay on the home loan long enough to benefit from the lower rate
Your budget and long-term goals
When your lender issues your preapproval, you'll see the maximum amount you may be able to borrow. But that doesn't mean you have to take the full amount. In fact, you may want to borrow much less if your priority is having money left over each month for investments, travel plans, or other goals.
A house is one of the biggest purchases you'll ever make, and you want to find a home that's comfortable and that you're excited to live in. But it's important to consider it in the context of other expenses and priorities.
If you take the maximum amount, will you have money left over for savings? For family outings? For the inevitable costs that crop up unexpectedly? The mortgage calculator can help you see different scenarios and compare them to what you want your housing budget to be.
Other factors that affect mortgage affordability
Your principal and interest will make up the bulk of the monthly payment on your new home. But there are several other variables as well.
- Homeowners insurance: Lenders require you to have homeowners insurance in place before you close on the loan. Premiums vary based on your coverage levels and where you live but expect to pay roughly $600-$1,500 a year. That's about $50-$125 a month added to your mortgage payment.
- Property taxes: The Census Bureau estimates the average homeowner pays about $2,500 a year in property taxes, though again, that amount can vary up or down based on where you live. But a $2,500 a year property tax bill translates to more than $200 added to your monthly payment.
- Mortgage insurance: If you take advantage of a low or no-down payment loan, you will likely owe mortgage insurance. Conventional loans with less than 20% down have private mortgage insurance (PMI) requirements, while FHA loans have an upfront and annual mortgage insurance premium (MIP). USDA loans also require upfront and ongoing mortgage insurance. VA loans do not have annual mortgage insurance, though there is an upfront funding fee. Mortgage insurance rates depend on your loan type, down payment, and credit score.
Your monthly mortgage payment explained
When you close on your home loan and make your first monthly mortgage payment, you'll be paying for several things all at once.
Here's a quick breakdown of the anatomy of your house payment:
This component repays the money you borrowed to buy your home. Early in a 30-year loan's amortization schedule, only a small portion of your payment will go toward your loan's principal.
Interest pays the cost of borrowing, measured as an annual percentage of your principal. Repayment schedules front-load your interest, so you're paying more interest than principal in the earliest years of a 30-year mortgage.
Many homeowners would struggle to come up with thousands of dollars all at once to pay annual homeowners insurance premiums and property taxes. So mortgage loan servicers collect these fees gradually by adding them to your mortgage payment.
You'll still make one mortgage payment, but your loan servicer will divert part of each payment into an escrow account. As the months pass, the escrow account grows. When a big annual tax or insurance bill comes due, the servicer pays it from your escrow account.
How much house can you afford with different types of loans?
Finding your best mortgage type will be key to optimizing how much house you can afford.
Conventional loans can be a great option if you have a credit score of 620 or higher and meet the other eligibility requirements, including a DTI of 45% or less.
High-credit borrowers may qualify for competitive interest rates on conventional loans, and you may be able to buy with as little as 3% down.
Additionally, there is no upfront mortgage insurance fee on a conventional loan, and the annual requirement falls off once you have 20% equity in the home.
FHA loans are government-backed, and borrowers with credit scores of 580 or higher can qualify with 3.5% down.
If you opt for an FHA loan, you will owe an upfront mortgage insurance premium of 1.75% of the loan amount. The annual MIP rate depends on your down payment and the size of your loan. But most FHA borrowers pay 0.85% for the life of the loan.
You can refinance to a conventional loan with no PMI once you reach 20% equity.
The U.S. Department of Agriculture insures home loans for low- and moderate-income homebuyers in rural and suburban areas. You can buy with no money down and with mortgage insurance that's more affordable than the FHA's.
But you'd need a credit score of about 640 or higher to qualify, and you'd need to earn less than 115% of your area's median income.
Active-duty servicemembers, veterans, and some surviving spouses may qualify for 0% down VA loans. Borrowers with full entitlement available can buy with no money down and no loan limits. There are no ongoing mortgage insurance premiums, though there is an upfront funding fee (borrowers with some service-related disabilities may be exempt from the funding fee).
Tips to increase how much house you can afford
If you run the numbers on this home affordability calculator and you're not happy with what you see, there are ways to boost your buying power.
- Pay down debts: Less debt shows a lender you can afford more
- Save up money in advance: Cash for a bigger down payment and discount points puts you in control
- Keep your bills under control: A history of on-time debt payments and low credit balances can raise your credit score
- Ask for a raise: Earning more makes more room in your budget for home buying
- Start a side hustle: A part-time job or a side hustle can spark more savings and help you pay down debt faster
- Reduce your monthly expenses: Sticking to a budget also helps with your savings, which you'll need for your down payment and closing costs and for repairs and maintenance once you buy a home
- Shop around lenders: Compare rates and fees from at least three different lenders; you never know who'll give you the best offer
The best way to know how much house you can afford? Get pre-approved.
Mortgage affordability calculators do a great job helping you estimate how much house you can afford.
But to find out your realistic price range, you need to get pre-approved. A preapproval tells you how much you can borrow and opens doors to the homes you want to see.
Home affordability calculator methodology
This home affordability calculator factors in your income, down payment, debts, mortgage rate, and even mortgage insurance to estimate a monthly payment.
It uses this payment to reverse engineer a home price that you may be able to afford.
The maximum payment is determined based on a default debt-to-income ratio of 41%. You can move this ratio higher or lower depending on your risk tolerance. For some loan types, lenders will consider DTIs above 50%. That means 50% of your before-tax income will go toward monthly debts and future home payments. But you might feel more comfortable with a lower DTI. Thirty-six percent is a commonly accepted conservative number.
The calculator also factors in homeowner's insurance, property tax, and HOA dues, if applicable. As with any calculator, you get more accurate results with accurate inputs. It could be a good idea to check out local property tax rates in the area you want to buy. Property taxes can vary widely from county to county or even from one neighborhood to the next.
Lastly, the calculator estimates your private mortgage insurance based on your down payment amount. Any down payment of less than 20% will require mortgage insurance. To avoid PMI, simply increase your down payment until you reach 20% of the suggested home price.
HOW MUCH HOME CAN I AFFORD – CALCULATOR DEFINITIONS
Annual income: The amount of combined pre-tax income for you and any co-borrowers.
Down payment: The number of funds you have allocated to put down on the home. The more you put down, the lower your payment will be, and the higher the home price you can afford.
Monthly debts: Debt payments for credit cards, student loans, auto loans, and other personal debt. Do not include other monthly expenses like utilities, groceries, cell phone bills, or rent.
Loan term: The number of years your lender sets to pay off the loan. The most common loan term is 30 years, but 10, 15, 20, and 25-year loans are available as well. Some lenders can even offer custom terms, such as 12 or 18 years.
Interest rate: The amount of interest you pay per year, expressed as a percentage of your loan amount. For example, you'll pay $4,000 per year in interest on a $100,000 loan at an interest rate of 4%.
Debt-to-income ratio (DTI): DTI compares your pre-tax income and all debt payments plus your future all-inclusive home payment. For example, if you make $8,000 per month and you pay $4,000 per month in debt payments plus future housing payments, your DTI would be 50%.
Homeowner's insurance: Lenders require you to maintain homeowner's insurance, which pays for the home to be repaired or rebuilt in case of fire or another disaster. Most homes cost between $50-$100 per month to insure. Note that this insurance does not include flood or earthquake protection. Those policies can be as much or more than the standard homeowner's insurance. If you need such policies, place the total insurance cost in this same box.
Property tax: The amount levied by your local jurisdiction each year when you own property. It's important to check property tax rates in the place you plan to buy since this cost can vary widely.
HOA dues: If your home is in a homeowner's association, you will probably have to pay HOA dues, which go toward the upkeep and maintenance of common areas. Note that HOA dues can apply to condos but also to single-family homes within a planned unit development or PUD.
PMI: Private mortgage insurance. This is insurance that your lender requires when you put down less than 20%. To eliminate this fee, increase your down payment amount until you've reached 20% of the calculator's suggested home price.