What Mortgage Can I Afford Based On Income

What mortgage can I afford based on income? To determine how much mortgage you can afford, a common guideline suggests that your monthly housing costs shouldn’t exceed 28% of your gross monthly income. For example, if you earn $5,000 a month, you could afford a mortgage payment of about $1,400. With a 30-year fixed-rate mortgage at 4%, this could translate to a loan amount of roughly $295,000. However, your overall debt-to-income (DTI) ratio, which should ideally stay below 36%, also plays a significant role in what you can afford.

Understanding Your Income and Affordability

What Counts as Income?

Before you can determine what mortgage you can afford, you need to clarify what counts as income. Generally, lenders look at your gross income, which includes:

• Salaries and Wages: This is your base salary before taxes.
• Bonuses and Commissions: If you receive bonuses or commissions regularly, they can be included.
• Rental Income: If you own rental properties, this income can also add to your affordability.
• Alimony or Child Support: In some cases, this can be factored into your income.

What’s Your Debt-to-Income Ratio?

Your debt-to-income (DTI) ratio is a crucial factor in determining mortgage affordability. It’s calculated by dividing your total monthly debt payments by your gross monthly income. For example, if your gross income is $5,000 and your monthly debt payments (including your future mortgage) total $1,800, your DTI would be 36%. Most lenders prefer a DTI ratio of 36% or lower.

Real-World Example: Sarah’s Situation

Sarah, a 35-year-old teacher in Denver, has a gross monthly income of $5,000. She’s got student loans and a car payment totaling $300 a month. This gives her a DTI ratio of 6% (300/5000). With her DTI under 36%, she’s in a good position. If she keeps her housing costs under 28%, she could afford a mortgage payment of around $1,400 a month, which translates to a loan of approximately $295,000 at a 4% interest rate.

Mortgage Types and Their Impact

Fixed-Rate vs. Adjustable-Rate Mortgages

When considering what mortgage you can afford, you’ll also want to understand the types of mortgages available.

• Fixed-Rate Mortgages: These loans have a constant interest rate and monthly payments that never change. They’re predictable and ideal for long-term planning. A 30-year fixed mortgage is the most common choice.

• Adjustable-Rate Mortgages (ARMs): These start with lower rates that can change after a set period, typically 5, 7, or 10 years. While they can be more affordable initially, they come with risks if rates rise significantly.

Real-World Example: John and Lisa’s Decision

John and Lisa, a couple in their early thirties, earn a combined gross income of $8,000 a month. They’re considering a mortgage for their first home. They can choose between a fixed-rate mortgage at 4% or an ARM starting at 3% for the first seven years. If they choose the fixed-rate mortgage, they can afford a payment of about $1,120 a month (28% of their income), allowing for a loan amount of around $236,000. If they take the ARM, their initial payment would be lower, but they’d need to plan for potential increases down the line.

Calculating Your Affordability

Use the 28/36 Rule

The 28/36 rule is a great guideline for understanding mortgage affordability. Here’s how it breaks down:

• 28% Rule: Your monthly mortgage payment (including principal, interest, taxes, and insurance) shouldn’t exceed 28% of your gross monthly income.
• 36% Rule: Your total monthly debt payments (including the mortgage, credit cards, and loans) shouldn’t exceed 36% of your gross monthly income.

Let’s Do Some Math

If your gross monthly income is $6,000:

• 28% of $6,000 = $1,680: This is the maximum mortgage payment you should aim for.
• 36% of $6,000 = $2,160: This is the total monthly debt limit, including your mortgage payment.

Real-World Example: Tom’s Calculation

Tom, a 40-year-old software engineer, makes $6,000 a month. Following the 28/36 rule, he can afford a mortgage payment of $1,680. With a 4% interest rate on a 30-year loan, he could qualify for a mortgage of around $350,000. However, if he has other debts totaling $500 a month, his total debt payment would be $2,180, putting him over the 36% limit. He might need to consider a lower mortgage amount or pay down some debt first.

Other Factors to Consider

Credit Score

Your credit score significantly impacts your mortgage options. A higher score usually means better interest rates. Most lenders prefer a score of at least 620 for conventional loans, but higher scores can lead to more favorable terms.

Down Payment

The size of your down payment affects your affordability too. A larger down payment reduces the loan amount, which can lead to lower monthly payments. Here are some common down payment percentages:

• Conventional Loans: Typically 5-20% of the home price.
• FHA Loans: As low as 3.5% down.
• VA Loans: No down payment required for eligible veterans.

Real-World Example: Emily and the Down Payment

Emily, a 30-year-old nurse, has saved $30,000 for a down payment on a $300,000 home. If she puts down 10% ($30,000), she’d be financing $270,000. With a 4% interest rate, her monthly payment would be around $1,290. If she could manage to save for a 20% down payment ($60,000), her loan would drop to $240,000, reducing her payment to about $1,145.

FAQs

1. How do I calculate how much mortgage I can afford?

To calculate how much mortgage you can afford, take your gross monthly income and multiply it by 28% for the maximum monthly payment. Then, consider your total debt payments to ensure they stay under 36% of your income.

2. What if I have student loans and credit card debt?

If you have student loans or credit card debt, those monthly payments will factor into your DTI ratio. To get a mortgage, your total debt payments, including your new mortgage, should ideally be under 36% of your gross monthly income.

3. Can I get a mortgage with a low credit score?

Yes, but options may be limited. FHA loans can be available to borrowers with scores as low as 580, but you may face higher interest rates. It’s best to work on improving your credit score before applying.

4. What are closing costs, and do they affect what I can afford?

Closing costs are fees associated with finalizing a mortgage and can range from 2-5% of the home price. These costs can impact your affordability if you plan to roll them into your mortgage rather than pay upfront.

5. How can I improve my chances of getting approved for a mortgage?

Improving your credit score, saving for a larger down payment, reducing debt, and ensuring stable employment can increase your chances of getting approved for a mortgage.

Conclusion

Determining how much mortgage you can afford based on your income involves understanding your income, debt-to-income ratio, and the type of mortgage you want. Use guidelines like the 28/36 rule and factor in your credit score and down payment. If you’re feeling overwhelmed, consider speaking with a mortgage advisor to help you navigate your options. Start by calculating your potential monthly payments and remember: taking the time to understand your finances now can lead to better decisions down the line.