People always ask all the time, “How much can I borrow for a mortgage based on my income?” I’ll explain the answer to you in simple terms.
By the way, have you ever wondered about that?
It is always refreshing to hear from first-time homebuyers who are just starting out and entering the real estate market. As with any loan, there are some factors you will need to calculate in order to determine what your budget is.
So, How Much Can I Borrow for a Mortgage Based on My Income?
This is a million-dollar question!
No one wants to spend too much on a home but people also want to be comfortable in their new home. There are many factors that go into determining your monthly home payment, such as property taxes, insurance, interest rates, and down payments.
You will need to factor in all these costs before you can determine how much you can borrow for a mortgage or get pre-approved for a mortgage.
Related: Different Types of Mortgage Loans
The simple rule is that you can afford a mortgage that is 2x to 2.5x your gross income.
That means, if your gross income is $15,000, you can afford a mortgage of $30,000-$37,500.
How to Borrow a Mortgage Based on Your Income
Go through these steps when seeking a mortgage loan. Your income should inform your choices.
Calculate the amount you can afford
The amount you can borrow for a mortgage depends on your income. It’s one of the biggest factors in determining whether you’ll get approved for a loan and how much you can borrow.
If you’re thinking about buying a home, your ultimate goal is to get a mortgage. And the first step to getting a mortgage is figuring out how much you can afford to spend.
Marketwatch’s mortgage calculator uses a series of questions to figure out the maximum amount you can borrow for a mortgage. It doesn’t provide an exact dollar figure, but it does provide a range that lets you know whether you should be looking at houses in the $100,000 range or the $700,000 range.
Here are some tips if you’re considering buying a house:
If you’re going to be financing with more than 20% down, make sure to fill out the calculator twice — once based on 15% and once based on 20%. Unless you have some extra cash lying around, it’s unlikely that you’ll be able to put 20% down.
That means your interest rate will be higher. If the difference in monthly payments is significant, or if it’ll take several years longer to pay off the loan, it might make sense to save up a larger down payment.
For most people, putting less than 10% down is dangerous territory — especially since mortgage insurance doesn’t cover as much as it used to — so I suggest avoiding any loan where you’re putting down less than 10%.
To determine how much you can afford, you need to take your monthly income and subtract your monthly housing costs. This includes – mortgage payments, taxes, and insurance, homeowner’s association fees, other monthly bills (if any).
After you’ve crunched the numbers, you can get an idea of how much house you can afford. Lenders often use debt-to-income ratios to determine how much house they can afford. That’s the total amount of your monthly bills divided by your gross income (before taxes).
The standard rule of thumb is that your housing costs shouldn’t exceed 28% of your gross income. Lenders may be willing to go higher, but only if you have enough assets to back up the loan. If it’s a conventional loan, your debt payments should be no more than 36% of your monthly income.
Related: How to Get Preapproved for a Mortgage
But those are just guidelines. Do what works for you and don’t get too caught up in the numbers game. Take into consideration any assets that could help you pay for a house — whether it’s a sizable savings account or investments that could be sold off in a pinch — and factor those out before deciding how much house you can afford.
Determine Your Qualifying Income
The first thing you need to determine when applying for a home mortgage is your “qualifying income.”
This is the amount of income that you have available to pay for your monthly mortgage payment, property taxes, and homeowners insurance.
How do you determine what is your qualifying income?
The amount of qualifying income needed to get a loan depends on:
– The size of the loan. The bigger the loan, the more money you will need to bring to closing.
– Your credit rating. If your credit score is 580 or higher, lenders will require less cash in reserves. Lenders also look at other factors such as your debt-to-income ratio, which is the percentage of total gross income that goes toward debt payments each month. A high debt-to-income ratio can translate into a greater chance of defaulting on a loan.
– Where you live. Some states have “high cost” areas where housing prices are significantly higher than average. In these areas, lenders may require even larger down payments and higher qualifying incomes.
Also Read: How to Get a Second Mortgage
Determine What You Can Afford With Debt Ratio
What do you need to know before you apply for a mortgage? You’ll have to determine your debt ratio.
Trying to decide how much house you can afford is a balancing act between how much you can borrow and how much debt you can comfortably handle.
Banks, S&Ls, and credit unions will look at several factors when deciding whether or not to approve a loan for a customer: the amount of income the borrower has, the amount of assets (savings, investments) the borrower has, and the amount of debt (such as credit card balances and auto loans) that the borrower has.
Banks will also look at your debt load, which is simply your total monthly payments for everything you owe divided by your monthly gross income.
If this ratio is higher than 36 percent, it’s considered “high” and may prevent you from getting approved for the loan.
Get Pre-Approved and Shop For a Loan
If you want to buy a house, it’s a good idea to apply for pre-approval for a mortgage. This ensures that you qualify for a loan of the size you want.
It also gives you more clout when shopping for a home.
Real estate agents, who typically get paid when homes sell, are much more likely to show you a house if you’re already pre-approved.
Getting pre-approved can also help with your home search by allowing you to focus on houses in your price range and avoid wasting time looking at homes that are out of your reach financially.
To get pre-approved, go to your bank or credit union and ask to talk to someone about getting pre-qualified.
They’ll sit down with you and look at your income and expenses, which is the first step in the mortgage approval process.
They’ll also pull your credit report so they can see what kind of debt and payment history you have. If they’re impressed by everything they see, they may be willing to give you an “official” pre-approval letter that details how much money they’re willing to lend you.
Now that you’ve got the green light from your bank, start shopping for homes in your price range. You can shop online or visit open houses
Search For the Best Mortgage Rates
Mortgage rates for either fixed or variable loans can help you save thousands of dollars in interest over the life of the loan.
Rates are based on how much money you will borrow, the type of loan you are applying for, and your credit score.
Mortgages are made with all kinds of different loan structures. The most common type is an adjustable-rate mortgage or ARM.
With this kind of mortgage, the rate is tied to the market and changes over time. Tied to the market means your payment could go up or down during the life of your loan, so it’s important to always check your best mortgage rates (mortgage rates change on a daily basis).
The best way to find the right one for you is to use a mortgage calculator. It will show you which type of loan you qualify for and what your monthly payment will be.
If you have bad credit, and that’s keeping you from getting approved for a mortgage, don’t worry — there are ways around it.
One of them is a piggyback loan, where you get a second loan from a private investor that’s secured by a second lien on your home.
The investor gets paid back first, then you pay off the lender who gave you the primary loan.
Apply for Your Mortgage
When you go to a bank to apply for a mortgage, the bank will ask you for some financial information.
The bank wants to make sure that you can afford the house. Part of the process includes “quoting” your income and your debt.
They will want to know how much money you make every month, and how much debt you have in total.
You need to show that you can afford the payments. Your annual income is an important part of the puzzle.
Even if you’ve got a good credit score, some lenders may reject your application if they think your income isn’t high enough. The amount of money you earn also affects what type of mortgage you qualify for.
For example, if you make $100,000 a year and want to borrow $250,000, some lenders will be willing to work with you — but a lender who only works with people who make less than $100,000 probably won’t be interested.
How Much Payment Can I Afford on That Home?
This is one of the most common questions asked by home buyers and one of the most difficult to answer. A lot depends on your lifestyle, goals, financial situation — and a host of other factors. The best way to determine how much you should spend on a home is to consider what mortgage payment you can comfortably afford.
Before you get started, there are some things it helps to know:
- Lenders use two basic guidelines, front-end ratios, and back-end ratios — to determine whether you qualify for a loan. These standards reflect different aspects of your ability to pay off your mortgage loan.
- Your front-end ratio represents the percentage of your gross monthly income that goes toward housing costs — principal, interest, taxes, and insurance. It’s calculated by dividing your total annual housing costs by your total gross monthly income. The higher this number is, the more house you can probably afford. Your lender may want this amount to be less than 28 percent of your total gross income (meaning that your housing costs don’t take up more than 28 percent of your income).
- Your back-end ratio is another way of looking at how much debt you may have in relation to your income.
Deciding how much home you can afford is a balancing act. You want to make sure your monthly housing costs (mortgage payment, taxes, and insurance) don’t exceed about 30% of your gross income. But lenders will also look at factors like your credit score and the amount of available cash for a down payment.
To get a rough idea of how large a mortgage you can afford, add up all of your monthly debts — credit cards, student loans, car payments — and multiply that amount by 0.28. That’s the maximum amount you should be spending each month on housing.
- Meet with a mortgage broker or bank to discuss your options
It’s important to know how much you can afford before you start shopping for a home. Your mortgage broker should run your income, assets, and debt through a computer program that will tell you how much you can borrow.
There are four main types of mortgages: fixed, adjustable, hybrid, and variable rate. Fixed mortgages have the lowest monthly payments because they’re based on consistent interest rates over a set period of time.
Adjustable mortgages start with low payments but rise later on. Hybrid loans have fixed and adjustable periods during which interest rates change, and variable-rate mortgages have floating rates that are based on an index or another security.
Tying your payment to a benchmark rate is smart if your income is likely to go up or down significantly in the next year or two. But if your finances are stable and predictable, consider locking in at a fixed rate for the life of the loan — it’s easier to manage long-term debt.
The most basic way to structure your payment schedule is with a 30-year fixed plan that allows you to make biweekly or monthly payments. The other option is an extended 15-year plan that allows you to pay less each month by extending the loan period by five years and paying more interest.
Nearly every mortgage loan application will require income verification. This is a simple process where you provide a paystub from your employer, along with your W-2 form.
Alternatively, you may be able to provide a signed, handwritten statement certifying that you are employed. Once the broker or bank has the documents required for income verification, they will be able to give you a more accurate estimate of what you can borrow and at what interest rate.
Asking for a pre-approval letter is another good way to estimate how much house you can afford. Pre-approval generally requires fewer documents than income verification because it’s based on the information you already provided in your loan application.
Just make sure that you shop around and get several estimates – each lender sets its own limits and rates so your pre-approval may be at one institution but not another.
The final method of determining how much you can borrow is by providing documentation of assets and debts. This is the most accurate method to determine how much house you can afford because it’s based on your actual financial position rather than just an estimate of income and expenses.
For example, if your employer provides a bonus or commission each year, this would be a great asset to list on the loan application.
Final Thoughts: How Much Can I Borrow for a Mortgage Based on My Income
The amount that you can borrow on your mortgage is based partly on your monthly household income. It’s helpful to calculate your income as accurately as possible so that a lender can give you a realistic figure.
After all, there is no point in trying to stretch the mortgage payments if it means you won’t be able to afford the mortgage and other living costs.