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What Size Mortgage Can I Afford?

What Size Mortgage Can I Afford?

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience

    One of the best ways to think about what size mortgage you can afford is to figure out how much of your gross income you are comfortable spending on your total monthly housing expense plus other monthly debt expense such as credit card, car and student loans as well as spousal and child support payments, if applicable.  Total monthly housing expense includes your monthly mortgage payment plus other housing-related expenses such as property tax and homeowners insurance as well as potentially applicable expenses such as homeowners association (HOA) dues, private mortgage insurance (PMI) or FHA mortgage insurance premium (MIP).

    Typically, lenders permit borrowers to spend a maximum of 43% to 50% of their monthly gross income on total monthly housing expense plus other monthly debt payments.  The maximum percentage of your monthly gross income that you are permitted to spend on monthly debt payments, including your mortgage payment, is called a debt-to-income ratio. Lenders use your debt-to-income ratio to determine what size mortgage you can afford.  We should highlight that your debt-to-income ratio is based on your monthly  gross income, or earnings before any deductions.  Additionally, the debt component for your debt-to-income ratio is based on your monthly debt payments, and not your total loan balance.  For example, if you make a $300 monthly car loan payment on a $10,000 car loan, the $300 figure is included in your debt-to-income ratio and not your $10,000 loan balance.

    While your debt-to-income ratio determines how much you are permitted to spend on total monthly housing expense plus your other monthly debt payments, in order to determine what size mortgage you can afford, you need to determine what size loan payment you can afford.  For example, if you make $6,000 in monthly gross income and have $500 in non-housing related monthly debt expenses, applying a debt-to-income ratio of 50% means that you can spend $3,000 on total total debt payments ($6,000 * 50% = $3,000). If you subtract $500 in non-housing related debt payments from $3,000, you get $2,500, which is the amount you can spend on your mortgage payment and other monthly housing expenses such as property tax and insurance. The good news is the less monthly debt you have, the more you can spend on your mortgage payment, which means you can afford a larger mortgage.

    As explained above, in addition to including your mortgage payment, total monthly housing expense includes property tax, homeowners insurance as well as other applicable costs so we need to subtract all these non-mortgage housing expenses to determine what size monthly loan payment you can afford. In this case, if property taxes, insurance and other non-mortgage monthly housing expenses are $300, that means you can afford a monthly mortgage payment of $2,200 ($2,500 - $300 = $2,200).  Please note that if the lender or your loan program uses a lower debt-to-income ratio, such as 43% instead of 50%, this reduces the monthly payment and mortgage amount you qualify for.

    After you determine what monthly mortgage payment you can afford, you can determine what size mortgage you can afford based on your mortgage rate, loan program and the length of your loan. The lower your mortgage rate, the higher the mortgage amount you can afford because your interest expense is less.

    The mortgage program you select also impacts what size mortgage you can afford. An adjustable rate mortgage (ARM) or interest only mortgage typically enable you to afford a higher loan amount than a fixed rate mortgage because your initial interest rate and monthly mortgage payment are lower. It is important to highlight that your mortgage rate and monthly payment can change and potentially increase with an ARM or interest only mortgage so you need to make sure that you can afford the mortgage and payment over the duration of the loan.

    The length of your mortgage, or mortgage term, also determines what size mortgage you can afford. Longer term loans, such as a 30 year mortgage, enable borrowers to afford a larger mortgage because the monthly payment is lower than for a loan with a shorter term, such as 15 year loan. When deciding what size mortgage you can afford be sure to consider the interest rate, loan program and term in your decision-making process.

    Other factors including your down payment and loan-to-value (LTV) ratio also influence what size mortgage you can afford.  If your LTV ratio, or the ratio of your loan amount to the fair market value of your property, is greater than 80%, then you are usually required to pay mortgage insurance, which is an added monthly expense that reduces the loan amount you qualify for.  On the other hand, if you make a larger down payment and your LTV ratio is lower than 80%, you may be able to qualify for a higher mortgage amount. 

    It is important to highlight that being able to afford a certain mortgage amount does not necessarily mean that you will be able to qualify for that mortgage amount.  Just because you can afford a monthly mortgage payment for a certain size mortgage does not always mean that a lender will lend you that amount of money.  There are several factors that influence your ability to qualify for a mortgage including your credit score, down payment and type of employment.

    Additionally, just because you qualify for a certain mortgage amount according to lender guidelines does not mean that is the right loan for you. The most important factor in determining what size mortgage you can afford is to be comfortable with both your monthly payment as well as total monthly housing expense in both the short and long term.  Borrowers should make sure that these costs fit within their monthly budget in light of their income, other spending and overall lifestyle.  The worst outcome when you get a mortgage is that you end up with a monthly payment that you cannot make.  Regardless of what a lender tells you, it is ultimately up to you to select the size mortgage you can afford.

  • Example: What Size Mortgage Can I Afford?
  • The two examples below illustrate how to answer the question what size mortgage can I afford?  The examples demonstrate how mortgage affordability is impacted by non-housing related monthly debt payments and show that the less monthly debt you have, the higher the loan amount you qualify for.

    In the first example below we look at a borrower that makes $6,500 in monthly gross income and has $500 in other monthly debt expenses.  The example follows three steps to determine the mortgage payment the borrower can afford.  The payment information is then used to calculate what size mortgage the borrower can afford based on an assumed interest rate (3.750%), loan program (fixed rate) and term (30 years). This example applies a 50% debt-to-income ratio so the borrower can spend half of his or her gross income on total debt expenses including the mortgage payment.  If you apply a lower debt-to-income ratio or higher interest rate, the loan amount the borrower qualifies for would be lower.

  • Borrower Mortgage Affordability Example #1
    Application of Debt-to-Income Ratio Results
    50% Debt-to-Income Ratio 50% of the borrower's monthly gross income equals $3,250
    • 50% * $6,500 in monthly gross income (debt-to-income ratio) = $3,250 in total monthly debt payments including monthly housing expense and non-housing debt payments
    • $3,250 - $500 in non-housing monthly debt payments = $2,750 in total monthly housing expense
    • $2,750 - $565 in property tax and insurance = $2,185 monthly mortgage payment
    Mortgage Size
    Mortgage Affordability
    • Based on the amount of monthly gross income that the borrower should spend on his or her mortgage payment and total monthly housing expense, the borrower can afford a mortgage of $471,495
    • Mortgage Affordability is based on a 30 year fixed rate mortgage at a 3.750% interest rate
    • A change in interest rate or mortgage term will change the size of mortgage the borrower can afford
    • The Loan-to-Value ratio (LTV) and type of mortgage program you select may also impact the size of mortgage you can afford
      • If your LTV is greater than 80%, you may be required to pay private mortgage insurance, or PMI, which is an extra ongoing cost in addition to your monthly mortgage payment and therefore reduces the size of mortgage you can afford
      • If you select an FHA mortgage program, you will be required to pay a Mortgage Insurance Premium (MIP), which is an extra up-front and ongoing cost in addition to your monthly mortgage payment and therefore reduces the size of the mortgage you can afford
  • In the second example below we look at a borrower that makes $6,500 in monthly gross income but has only $100 in monthly debt expense and calculate what size mortgage the borrower qualifies for.  The other assumptions for debt-to-income ratio, mortgage rate and loan program remain the same.  While the total amount of money the borrower can spend on monthly debt payments is the same in both examples ($6,500), because the borrower has less non-housing related debt expenses, he or she can spend more on the mortgage payment.  This example illustrates that the lower your monthly debt expense, the larger the mortgage you can afford.

  • Borrower Mortgage Affordability Example #2
    Application of Debt-to-Income Ratio Results
    50% Debt-to-Income Ratio 50% of the borrower's monthly gross income equals $3,250
    • 50% * $6,500 in monthly gross income (debt-to-income ratio) = $3,250 in total monthly debt payments including monthly housing expense and non-housing debt payments
    • $3,250 - $100 in non-housing monthly debt payments = $3,150 in total monthly housing expense
    • $3,150 - $650 in property tax and insurance = $2,500 monthly mortgage payment
    Mortgage Size
    Mortgage Affordability
    • In this example, based on the lower amount of non-housing monthly debt that the borrower has, the borrower can afford a larger mortgage amount of $540,000
    • Mortgage Affordability is based on a 30 year fixed rate mortgage at a 3.750% interest rate
  • As these examples demonstrate, what size mortgage you can afford is impacted by several factors and the most important point is to make sure that you are comfortable with your loan amount and monthly payment.  No one wants to end up mortgage or house poor so select a loan that fits within your financial budget. Because mortgage affordability and qualification guidelines vary by lender we recommend that you contact multiple lenders in the table below to understand your financing options.  Shopping for your mortgage enables you to find the lender and loan that are right for you.  

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  • View the instructional video below to learn more about what size loan you can afford.

  • FREEandCLEAR Mortgage Instructional Video

    What Size Mortgage Can I Afford? Instructional Video

  • Great Mortgage IdeaRelated FREEandCLEAR Resources

  • Sources

    Loan Amount Guidelines: https://www.fanniemae.com/content/guide/selling/b3/6/02.html

    Mortgage Affordability: http://myhome.freddiemac.com/buy/mortgage-rates-affordability.html

About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR. More about Harry

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