How Much Mortgage Can I Afford Based on My Income?

Home is where so many of life’s great memories blossom. Unfortunately, it’s also where financial stress comes to roost when buyers stretch themselves too thin, overestimate their financial wherewithal or see their best intentions of building equity sabotaged by an unforeseen development.

In answering the question “How much house can I afford,” information is your best friend.

“I generally tell buyers that at today’s low interest rates they can qualify for 2 1/2 times their gross annual income,” said Gregg Wasilko, president of Howard Hanna’s Wasilko Group in Cleveland, Ohio. “So, if you make $100,000 a year you can qualify for a mortgage of $250,000.

“In no event should their total monthly debt which includes mortgage, car payments, student loans, credit cards and other installment debt exceed 36% of their gross monthly income.”

A real estate agent or lender can help in myriad ways but the safest play for buyers involves more than asking the experts what size mortgage you can qualify for given your current income and installment debt.

Based on a fairly standard formula used in the industry, that number in many cases will be higher than what your individual circumstances dictate you can comfortably afford month to month and year to year.

Is your job permanent? Is your position secure? What is your earning potential at that job? Do you have expensive hobbies? Monthly prescription drug costs? Club memberships? Where are you willing to make lifestyle cutbacks to thrive in the housing market?

Creating a Budget

Typically, a real estate agent or broker won’t ask you to create a monthly budget. Installment debt is the main factor for lenders in mortgage qualification.

But creating a budget not only offers peace-of-mind benefits about buying a home, it can help you pinpoint areas you might cut back to save for those inevitable rainy days known all too well to homeowners.

Your income and fixed expenses — car payments, insurance, credit cards, student debt, etc. — is the first place to start in making a monthly budget.

A deeper dive should include a look at:

• Your future home’s utility bills, e.g. gas, trash, water, electricity. Especially if you’re not paying for all of those in your current living situation.
• A tabulation of your variable expenses: groceries, gas, entertainment, pet costs, travel expenditures, cell phone bills and/or streaming services.
• Some experts advise budgeting 1% to 4% of your home’s value on an annual basis to pay for that new roof, replace the leaky water heater or to give the house the new coat of paint it sorely needs. Budget more depending on the age of the house you’re buying or certainly if it’s a full-blown fixer-upper.

Can I Afford a Mortgage?

So much is involved in buying a house you can afford — interest rates, credit score, closing costs, home insurance, bidding in a competitive market — that it can seem daunting. Getting into the market is the biggest investment many will make. It can also be one of the best.

“Interest rates are still at historic lows, despite COVID, supply chain issues, debates over infrastructure and other issues in Washington, low inventory of housing stock and high demand across the U.S.,” said real estate broker Liz Van Lenten with Compass in La Grange, Illinois.

“So it can be a great time to buy. In fact, many people who’ve been renting now realize in many cases they can do better with a purchase than with a monthly rent.”

Lenders look at a number of factors to determine if you qualify for a mortgage. They include income, debt, credit and employment. It’s your job to look at all mortgage-related expenses. Make sure the calculation for your mortgage payment takes into account insurance on your home, for instance.

“You can quickly determine your options by having a mortgage broker run the numbers for you, which costs you nothing and then talking to your real estate broker about creating a search based on your budget range,” said Van Lenten.

“Getting a handle on what you can afford will also help you identify if there are things that can be done to improve your purchase price and budget, such as enhancing your credit ranking.”

Remember that there is a difference between what you qualify for (how much money a lender is willing to give you) and how much you can afford (based on your lifestyle and other considerations).

Experts agree that your monthly mortgage payment should not exceed 28% of your total gross monthly income. Here’s how to calculate your maximum monthly mortgage payment:

Maximum Monthly Mortgage Payment = (Annual Salary x .28 %)

Your mortgage payment is composed of PITI – Principal, Interest, Taxes and Insurance.

Principal of your mortgage + Interest on the mortgage + Taxes on your property + Insurance on your home and mortgage (if any).

Other Factors That May Affect How Much Home I Can Afford

In no particular order, the components that will determine how much house you can afford:

• Annual income – Your total amount earned before taxes and deductions. It’s the baseline for how much home you can qualify for and afford. How much you bring in every month affects every aspect of the decision-making process for buying a home.
• Credit score – It’s smart to check this before you get started. Take time to bolster it if it’s low. Making on-time payments on all bills is the fastest way to improve a credit score. Your interest rate will benefit.
• Down payment – Down payment assistance programs could help if you don’t have the preferred 20%.
• Debt-to-income ratio – This is a comparison of your monthly debt to your monthly income. A high DTI gives lenders pause for obvious reasons.
• Closing Costs – Can range anywhere from 2% to 5% of your home’s price.
• Home Owner’s Association (HOA) Dues – An added monthly cost in the purchase of many condos and townhomes.
• Interest Rate – A major factor in affordable payments directly tied to credit score and down payment.
• Loan Term – Standard term is 30 years but the term depends on the type of home loan.

Understanding Different Types of Mortgages

If you’re like many Americans in the job market (86% as of 2019), you’re not able to roll a wheelbarrow full of cash into the home buying transaction. You’re going to have to take out a mortgage.

There are different types of mortgages that can make a big difference in how much home you can afford. Fixed-rate versus adjustable rate may be your first decision.

In a fixed rate mortgage, the interest rate stays the same for the length of the loan.

The payment never changes.

Typically, adjustable rate mortgages (ARM) start out lower than a fixed-rate mortgage. An ARM often is fixed for a short period of time but then is subject to change.  While ARMs are capped to limit how high (or low) they can go, they’re a bit of a gamble.

Your real estate agent can easily calculate the difference in payment between a 30-year fixed rate mortgage and an adjustable rate mortgage while also helping you find a mortgage lender who can provide all the information you’ll need concerning other options, such as:

• Federal Housing Administration (FHA) Loans. Designed to help low- and medium-income borrowers. But they carry the extra cost of upfront mortgage insurance and monthly mortgage insurance payments.
• VA Loans for veterans. The only widely available mortgage that requires no down payment and waives the minimum credit score. They have military service minimum requirements and, in most cases, also carry a one-time VA funding fee.
• Conventional Loans. Issued by private lenders, these comprise about 65% of all home loans. They require a minimum credit score (in the 640 range) and a debt-to-income ratio of 43% or lower. If you don’t have 20% to put down, you’ll also pay private mortgage insurance.
• USDA Loans. Meant to encourage homeownership in small, rural communities, they’re guaranteed by the U.S. Department of Agriculture. They offer low interest, low down payment options for buyers with low to moderate incomes. Restricted to communities under 35,000 population. With USDA-guaranteed loans, your income can’t exceed 15% over the median income for the area.

What Mortgage Can I Qualify for If I Earn $30,000 a Year?

Let’s look at a hypothetical situation. A homeowner — we’ll call her Fannie — makes $30,000 a year and wants to know how much home she can afford. She has done well to save a down payment of $8,000.

Using the general formula one of our real estate experts provided earlier, Fannie might qualify for a mortgage 2 ½ times her gross annual income best-case scenario. That puts her in the neighborhood of a $75,000 mortgage taking into account her down payment. But that’s just a general formula.

Let’s determine her maximum monthly payment as best we can, keeping in mind that her payment shouldn’t exceed 28% of her gross monthly income.

($30,000 x .28%) ÷ 12 = $700.

Ideally, Fannie should not have a monthly payment that exceeds $700 per month. This must include PITI as well as the homeowner’s association fee (if any). Using a mortgage calculator, we can see that Anna’s monthly payment would be $626 on a $83,000 mortgage, considering only the following monthly obligations:

• Mortgage: 30 year fixed
• Mortgage rate: 3.125%
• Insurance: $132
• Taxes: $73
• PMI: $100
• Downpayment: $8000

Fannie is probably not debt free. Her total monthly debt payments, including mortgage, car loan, student loans and credit card debt payments should not exceed 36% of her gross monthly income. That means that if she is paying 20% of her monthly income toward non-mortgage debt, she only has 16% of income left for the house payment.

If Fannie’s auto, student loan and credit card payment comprise 20% of her monthly income, her mortgage payment should be closer to $400. In this scenario, that $83,000 house and $75,000 mortgage are significantly beyond her comfort level.

In order to increase the amount of money available for a mortgage, Anna should wait and pay down some of her debt.

Use our How Much Home Can I Afford Calculator to see how your income, expenses, down payment and interest rates affect your monthly payment and affordable purchase price.

Buying a Home

Buying a home is considered the safest investment a person can make for a good reason. The Bureau of Labor Statistics says that in 2011, the average price of homes in the U.S. was $219,104. The average price in 2021 was $278,650, an increase of $59,546.

If you owned an “average” home, that’s a 27% return on your investment. Any investor would call a 27% return phenomenal. It clearly demonstrates the benefits of owning a home.

If you can’t afford the house you want now, it’s still a good idea to consider something less expensive, like a mobile home. The cost is significantly less, so financing for a mobile home should be much easier.

The return won’t be as high as you would expect from a house when you’re ready to sell, but a positive cash flow should still come from it and help you move on to the next level of housing you can afford.