Start with your debt-to-income ratio

Most lenders look at your debt-to-income ratio — the percentage of your monthly gross income that goes to debt payments. This is the first number that determines whether a lender will consider you for a mortgage and how much they might lend.

To calculate it, add up all your monthly debt payments: car loans, student loans, credit cards, child support, and any other regular obligations. Divide that total by your gross monthly income (before taxes). Multiply by 100 to get a percentage. For example, if your monthly debts are $800 and your gross monthly income is $4,000, your ratio is 20 percent.

Most conventional lenders want to see a ratio of 43 percent or lower, though some will go higher. Federal Housing Administration (FHA) loans sometimes accept ratios up to 50 percent. The lower your ratio, the more a lender will trust you to take on a mortgage payment without falling behind on other obligations.

Key Takeaways

  • Your debt-to-income ratio — the percentage of your monthly income going to debt — is the first filter lenders use, and most want to see 43 percent or lower.
  • The 28/36 rule is a common guideline: housing costs should not exceed 28 percent of gross income, and total debt should not exceed 36 percent.
  • Down payment size, credit score, and savings for closing costs and emergencies all affect what price range you can actually manage, not just what a lender will approve.
  • FHA loans require a smaller down payment than conventional mortgages, but they add mortgage insurance costs that increase your monthly payment.
  • A mortgage preapproval letter shows you a realistic borrowing range based on your actual finances, not a maximum you should spend.

explore the 28/36 rule to your specific income

The 28/36 rule is a practical guideline used by lenders and financial planners. It says your housing costs — mortgage payment, property taxes, homeowners insurance, and mortgage insurance if you have it — should not exceed 28 percent of your gross monthly income. Your total debt payments should not exceed 36 percent.

To use this rule, multiply your gross monthly income by 0.28. That is your maximum monthly housing budget. For example, if you earn $3,500 gross per month, 28 percent is $980. That $980 must cover your mortgage principal and interest, property taxes, homeowners insurance, and any mortgage insurance.

This rule is a ceiling, not a target. Many people spend less and still have room in their budget for emergencies, savings, and other expenses. The rule assumes you have no other major debt; if you do, your actual comfortable housing budget may be lower.

Calculate what monthly payment you can afford

Once you know your maximum monthly housing budget, you can work backward to a home price. A mortgage calculator (available free from most banks and financial websites) will show you what loan amount produces a given monthly payment at current interest rates.

The monthly payment depends on three things: the loan amount, the interest rate, and the loan term (usually 15 or 30 years). A lower interest rate and a longer term both lower the monthly payment. A 30-year mortgage at 7 percent interest on a $250,000 loan produces a different monthly payment than a 15-year mortgage at the same rate.

Remember that the monthly payment is only part of your housing cost. Property taxes vary by location and can range from less than 1 percent of home value annually in some states to over 2 percent in others. Homeowners insurance varies by location, home age, and coverage level. Mortgage insurance (required if your down payment is less than 20 percent) adds another cost. Use a mortgage calculator that includes these items, not just principal and interest.

Account for down payment and closing costs

The down payment is money you pay upfront; it reduces the amount you need to borrow. A larger down payment lowers your monthly payment and may lower your interest rate. A smaller down payment means a higher monthly payment and usually requires mortgage insurance.

Conventional mortgages typically require a down payment of at least 3 to 20 percent of the home price. FHA loans require a minimum of 3.5 percent down. VA loans (for military members and veterans) may require zero down. The lower the down payment, the more you borrow and the higher your monthly cost.

Closing costs are fees paid at the time you sign the mortgage documents. They typically range from 2 to 5 percent of the loan amount and cover appraisal fees, title search, attorney fees, and lender fees. You need cash on hand for closing costs; you cannot borrow them as part of the mortgage. If you have $15,000 saved, and closing costs are $8,000, you have $7,000 left for a down payment.

Check your credit score and interest rate impact

Your credit score affects the interest rate a lender will offer. A higher score usually means a lower rate; a lower score means a higher rate. The difference can be significant: a borrower with a 740 score might get a 6.5 percent rate, while a borrower with a 620 score might get 7.8 percent on the same loan amount and term. That 1.3 percent difference adds hundreds of dollars to your monthly payment.

You can check your credit score free once per year through annualcreditreport.com, which is the official site run by the three major credit bureaus. Many banks and credit card companies also show your score free in their online portals. Knowing your score before you talk to a lender helps you understand what rate range to expect.

If your score is lower than you expected, you have options. Paying down existing debt, correcting errors on your credit report, and waiting for negative items to age can all improve your score over time. Some lenders work with lower scores, though at higher rates. An FHA loan may be available to you even if a conventional lender declines.

Get a preapproval letter to see your actual borrowing range

A mortgage preapproval is a letter from a lender stating how much they will lend you based on your income, debts, credit score, and assets. It is not a may provide, but it is based on your actual financial information, not a general estimate.

To get preapproved, you will provide the lender with recent pay stubs, tax returns (usually the last two years), bank statements, and a list of debts. The lender will pull your credit report and verify your employment. This process usually takes a few days to a week.

The preapproval letter shows a maximum loan amount, but that maximum is not the same as what you should spend. A lender may preapprove you for $350,000 because your debt-to-income ratio technically allows it, but that does not mean a $350,000 mortgage fits your actual budget after taxes, insurance, childcare, transportation, and other expenses. Use the preapproval as a ceiling, not a target.

Factor in property taxes, insurance, and maintenance costs

The monthly mortgage payment is only one part of homeownership cost. Property taxes are set by your local government and vary widely by location. In some counties, property tax is under 0.5 percent of home value per year; in others, it is over 2 percent. A $250,000 home in a high-tax area might cost $400 per month in property taxes alone.

Homeowners insurance is required by lenders and covers damage to the structure and liability. The cost depends on the home's age, location, construction type, and the coverage level you choose. Insurance in areas prone to hurricanes, floods, or wildfires costs more. Budget $100 to $300 per month as a starting point, though your actual cost may differ.

Maintenance and repairs are not a monthly payment, but they are a real cost. Older homes, homes with older roofs or HVAC systems, and homes in areas with harsh weather typically cost more to maintain. Many financial advisors suggest budgeting 1 percent of the home's purchase price per year for maintenance, though this varies widely.

Frequently Asked Questions

What if my debt-to-income ratio is too high right now?

You can lower it by paying down existing debt before you explore for a mortgage. Paying off a car loan or credit card balance reduces your monthly debt payments and improves your ratio. Even a few months of focused paydown can move you into a range where lenders will work with you. Increasing your income also lowers the ratio, though that is usually slower.

Can I afford a house if I have student loans?

Yes, but student loans count as debt in your debt-to-income ratio. If you are on an income-driven repayment plan, lenders use your actual monthly payment amount. If you are not yet repaying (in school or deferment), lenders may estimate a payment based on the loan balance. The higher your student loan debt, the lower the home price you can afford.

Is an FHA loan a good option for lower income buyers?

FHA loans allow a smaller down payment (3.5 percent) and accept higher debt-to-income ratios than conventional loans, which can open homeownership to people who would not may have access to otherwise. However, FHA loans require mortgage insurance for the life of the loan (or at least 11 years), which increases your monthly payment. Compare the total monthly cost of an FHA loan to a conventional loan before deciding.

What happens if I get preapproved but my financial situation changes?

A preapproval is valid for a limited time, usually 60 to 90 days. If you lose income, take on new debt, or change jobs during that period, you should tell your lender before you make an offer on a house. Major changes can affect your preapproval amount or your interest rate.

Should I use all of my savings for a down payment?

No. You need cash reserves for closing costs, and you should keep an emergency fund separate from your down payment. Most lenders want to see that you have savings left after closing. A common guideline is to keep three to six months of housing costs in reserve, though your situation may differ.