What determines how much house you can afford?
Updated October 16, 2024, 2:45 AM EDT
If you're interested in enjoying the benefits of homeownership, now could be an optimal time to buy thanks to low mortgage rates.
The coronavirus pandemic has prompted the federal government to take steps to boost the economy, including cutting mortgage rates. That, in turn, has led to near-record low mortgage interest rates and a strong real estate market, creating an opportunity for buyers who are able to support a home loan.
Part of the home buying process involves knowing how much house you can afford. Here's what you need to know.
4 factors that determine how much house you can afford
Using an online mortgage calculator can help you estimate monthly mortgage payments and narrow down home prices in your range. You'll need to make sure you can afford these monthly payments — and consider how these four factors affect your options as you search for the perfect home.
- Annual salary
- Credit score
- Debt-to-income ratio
- Interest rate
1. Annual salary
Annual salary is one thing lenders consider when getting a mortgage to purchase a home. After all, mortgage lenders need to know that you can afford to make your monthly payments.
Your income doesn't impact your credit score directly, but it can affect your ability to get a home loan. There's no salary threshold that mortgage lenders look for in the mortgage process, but you do need to be able to verify what you make.
This typically means providing:
- Copies of your pay stubs
- W-2s and copies of your tax returns
- 1099s and copies of your tax returns if you're self-employed
- Verification of employment
2. Credit score
Credit scores are a measure of how responsibly you manage your finances. Unlike income, mortgage lenders can use established minimum credit score guidelines to determine whether to approve you for a home loan.
For example, if you're interested in a conventional loan Fannie Mae guidelines set the minimum credit score at 620. But if you're looking for an FHA loan, it's possible to qualify with a credit score as low as 580.
If you're interested in knowing how your credit score may affect your ability to get a mortgage and purchase a home, you could get prequalified or preapproved. Being prequalified can give you an idea of what loan terms you're likely to qualify for while mortgage preapproval makes it easier to gauge how much house you can afford.
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3. Debt-to-income ratio
Your debt-to-income ratio means how much of your monthly income goes toward debt. Mortgage lenders use this, along with your annual salary, to gauge how likely you are to be able to keep up with your monthly payments.
Lenders can use the 43% rule when approving a first-time homebuyer or any other buyer for a mortgage. Essentially, you wouldn't be able to qualify if your monthly mortgage payments and other debts exceed 43% of your monthly income. The more debt you have, including credit cards or student loans, relative to your income, the more that can shrink how much of a mortgage you're able to qualify for.
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4. Interest rate
The interest rate you're assigned to a mortgage can also affect how much home you can afford. A lower interest rate can mean a lower monthly payment. The lower your monthly payment, the more affordable a mortgage becomes, even when the home's price is at the higher end of your budget.
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Other costs of homebuying
If you're a first-time homebuyer, you may not be aware of the other costs associated with homeownership. For example, in addition to your monthly mortgage payments your homebuying budget should also include:
- Your down payment
- Closing costs
- Appraisal and inspection fees
Beyond that, you may want to consider ongoing expenses such as maintenance, upkeep, and repairs. Those can all add to the cost of buying and owning real estate.
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The bottom line
If you decide to buy a home, it's helpful to understand the basics of the mortgage process and how it works. That includes comparing mortgage loan programs and looking for ways to save money. Financial assistance programs, for example, can offer help with down payment funds and closing costs for qualified buyers.
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