When you’re shopping around for a new home, price and monthly payment estimates can determine what you end up buying. But all those numbers mean nothing unless you understand the context.

In this article, we walk you through finding out how much mortgage you can afford, step-by-step.

Table of Contents

What determines how much a mortgage costs?

There are several other factors besides the value of the home that impact the amount of your monthly payment. Here are the most important:

Down payment

A down payment is a percentage of the overall price of your home that you pay at closing. Usually, you want to put down 20 percent of the home’s value.

It can take years to save for a sizeable down payment. For example, if the home you want is valued at $150,000, a 20 percent down payment would be $30,000. This is 89 percent of the average American salary of $33,706, as reported by BLS in 2018.

Not being able to afford a down payment is a common obstacle to homeownership. Especially if you already have several monthly debt payments for things such as student loan debt, credit cards and auto loans, it may be difficult to save.

Follow these steps to see how long it would take you to save enough for a down payment on your ideal home:

  1. Multiply the value of your ideal home by 0.20. This will give you the amount of the down payment.

NOTE: If you want to make a higher down payment or you have a loan/program that allows you to pay less, use that percentage in place of 0.20.

  1. Divide the down payment by the number of years you have to save. For example, if you want to buy a new home in five years, divide the down payment by five. This will give you the amount you must save each year to afford the down payment.
  2. Divide the yearly savings from step 2 by 12. The result is the amount you must save monthly to have enough money for the down payment on your ideal home by your target date.

If this number seems out of reach, don’t worry. There are first-time homebuyer programs, FHA loans, and VA loans that may allow you to pay a lower percentage of the home’s value for a down payment.

Additionally, your down payment will affect the amount of your monthly mortgage payment. The more you pay upfront, the lower your monthly payments can be.

Type of mortgage

The two main types of mortgages are fixed-rate and adjustable-rate. Fixed-rate mortgages have the same interest rate for the entire life of the loan. With this type of loan, your basic payment will be the same every month until you pay it off (barring changes in property taxes and insurance).

Adjustable-rate mortgages, on the other hand, have interest rates that can change according to the market. There are also hybrid mortgages that have an adjustable rate for the first several years and then switch to a fixed rate or vice versa. Adjustable rates mean that your monthly payment can change from year to year, so you must make sure you could afford a higher payment if rates rise.

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Term of loan

The length of your loan also affects how much you pay per month. The most common terms are 30 years and 15 years, but you can also get 10-year or even 5-year loans. The longer the life of the loan, the lower the monthly payment; a 30-year mortgage will have lower monthly payments than a 15-year mortgage.

However, this can be a double-edged sword. Sure, a longer-term loan will get you a lower monthly payment. But you will pay more total interest in the end. With a 15-year loan, your monthly payments will be higher, but you will pay less total interest.

Interest rate

Your mortgage’s interest rate heavily influences the cost of your monthly payment. The purchase price of your home minus your down payment represents the principal amount of the loan. Your interest charges are calculated by multiplying the principal amount by the interest rate percentage of your loan.  The higher your interest rate, the higher your payments will be and the more your home will cost over the term of the loan.

The interest rate on your loan is influenced by the current market rates, your credit score, and your credit history. It can vary among lenders, so make sure to shop around for the lowest rate.

Property taxes and insurance

Real estate taxes and property insurance can also drive up the amount you pay. These are usually charged yearly, so if you want to see what you would have to save monthly, just divide the totals by 12.

Crunching the numbers

Finally, let’s get down to the real question here: How much mortgage can you really afford? Use our calculator to get a quick answer and read about the 28/36 rule below for a little more insight:
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The 28/36 rule

This rule helps you determine the most you can afford to pay for your mortgage. To start, you must first determine your household’s gross monthly income.

Your gross monthly income is what your family earns per month before taxes and other deductions. Once you have this number, get out your calculator and start finding these percentages:

  • 28%: Your total monthly housing expenses (when you factor in your potential mortgage payment) should not be greater than this percentage of your gross monthly income.
    • Example: If your household’s gross monthly income is $4,500, multiply 4,500 by 0.28. This gives you $1,260. Therefore, when shopping around for mortgages, you’ll have to make sure the monthly payment will be no greater than $1,260.
  • 36%: Your total debt payments should be less than or equal to 36% of your gross monthly income. This ratio is also called your debt-to-income ratio (DTI).
    • Example: If your household’s gross monthly income is $4,500, multiply 4,500 by 0.36. This gives you $1,620. If your monthly debt payments are greater than $1,620, you may have trouble paying your mortgage.

NOTE: Just because you can afford it doesn’t guarantee you will be approved for the mortgage you want.

How much house can I afford with an FHA loan?

FHA loans are backed by the Federal Housing Administration. They’re designed for buyers who don’t have good credit and/or can’t save enough for a down payment.

A down payment on an FHA loan is usually only 5 or 10 percent, depending on your credit score. This makes the down payment less of an issue.

An FHA loan may increase what you think you can afford, but you still need to calculate your monthly payments and ensure they are reasonable for your budget. There are also limits on how much you can borrow with an FHA loan depending on where you live, which you can read about here.

You will also need to factor in an added Mortgage Insurance Premium (MIP) with an FHA loan. This is premium is required for all FHA loans, regardless of the size of your down payment. MIP protects the lender in case you default on the loan. Be aware that MIP will increase your monthly housing expenses.

How much house can I afford with a VA loan?

Like an FHA loan, a VA loan is backed by the government and can help you more easily afford a home and secure a lower down payment. However, there are limits. Your debt-to-income ratio must be 0.41 or below when you factor in the potential mortgage payment.

Article last modified on April 26, 2021. Published by Debt.com, LLC