How lenders determine how much house you can afford

Lenders use several factors to calculate how much they’re willing to loan you.

“Expect lenders to focus on these core things: income, existing debt, and your credit history,” says Jake Vehige, president of mortgage lending at Neighbors Bank. “A lender is looking to understand what a borrower earns consistently, and compare that to the monthly obligations they have and how credit has been managed over an extended period of time.”

Your credit score plays a major role in what you’ll qualify for. A higher score unlocks better interest rates and loan terms, which directly affects how much you can afford. Even a small difference in your rate can change your monthly payment by hundreds of dollars.

Your down payment also matters. A larger down payment reduces the loan amount you need, which lowers your monthly payment and can help you avoid private mortgage insurance (PMI) if you put down at least 20%.

How income and debt affect your mortgage payment

Your income sets the upper limit of what lenders will loan you, but your existing debt reduces that amount. Lenders calculate your debt-to-income ratio (DTI)—the percentage of your gross monthly income that goes toward debt payments, including your future mortgage.

Most lenders prefer a DTI of 43% or lower, though some loan programs allow higher ratios, according to Vehige. If you’re carrying high debt, you’ll qualify for a smaller mortgage. For example, if you earn $6,000 per month and have $1,500 in monthly debt payments, your DTI is 25%. Lenders will add your estimated mortgage payment and ensure your total DTI stays within acceptable limits.

Note: Lenders look at gross income—what you earn before taxes and deductions—not your take-home pay. Also, lenders want to see income that is stable and predictable, not based on bonuses or variable pay structure.

How your down payment changes what you can afford

Your down payment size directly affects your home loan options, your potential monthly mortgage payments, and overall affordability. A larger down payment means:

• Lower loan amount, which reduces your monthly payment
• Better interest rates in some cases
• No PMI requirement if you put down 20% or more
• More equity in your home from day one

For example, on a $300,000 home:

• With 5% down ($15,000), you’d borrow $285,000
• With 20% down ($60,000), you’d borrow $240,000

That $45,000 difference in loan amount could save you $200-300 per month depending on your interest rate—and thousands of dollars over the life of the loan.

Other costs to budget for beyond your mortgage payment

Many first-time buyers focus solely on the mortgage payment and forget about the additional costs of homeownership. But even before closing, you’ll need to budget for additional closing costs, which are typically 2%-5% of the purchase price upfront.

“Closing costs are often underestimated because buyers focus on the home price and down payment, but don’t plan for the full ‘cash-to-close’ total,” says Brooks. “That total can include lender and title fees, escrow and settlement charges, real estate agent fees, and other transaction costs that come due at closing.”

Then there are the ongoing expenses of homeownership that can add hundreds—of even thousands—of dollars to your monthly housing costs. Lenders will be factoring these additional fees into their calculations, so here’s what to budget for:

• Property taxes: Vary widely by location. In some areas, property taxes can add over $500 per month to your housing costs.
• Homeowners insurance: Required by lenders. Costs depend on home value, location, and coverage level.
• HOA fees: If you’re buying a condo or in a planned community, monthly HOA fees can range from $100 to over $500.
• Maintenance and repairs: Expect to spend 1-2% of your home’s value annually on upkeep. For a $300,000 home, that’s $3,000-6,000 per year.
• Utilities: Often higher than renting, especially for larger homes.
• PMI: If you put down less than 20%, expect to pay 0.5%-1% of the loan amount annually until you reach 20% equity.

Paragraphs by Eric Goldschein on realtor.com

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