Mortgage lenders are chiefly concerned with your ability to repay the mortgage. To determine whether you qualify for a loan, they will consider your credit history, your monthly gross income, and how much cash you'll be able to gather for a down payment. So how much house can you afford? To know that, you need to understand something called the debt-to-income ratio.
DTI is the money you owe each month compared to what you make. In general, to qualify for a mortgage, this ratio should not exceed 36%. (There are exceptions, but they are too rare to discuss here.) Your DTI is simply your total monthly debt payments divided by your monthly earnings (before taxes).
For example, if your gross income is $2,800 a month and you pay $550 for credit cards, an auto loan, and other debts, your DTI is 20% (550 ÷ 2,800).
There are two major flaws built into DTI (gross income isn't what you actually take home, and life has a lot more monthly expenses than just debt payments), but since all lenders calculate DTI the same way it works for them as a measure of how comfortably a person can make mortgage payments.
As stated, your total monthly debt obligation should not exceed 36% of your gross income. To calculate your debt-to-income ratio, multiply your annual salary by 0.36, then divide by 12 (months). The answer is your maximum allowable debt-to-income ratio.
Here's a look at typical debt ratio requirements by loan type.
In addition, lenders include the cost of taxes and insurance when calculating how much house you can afford.
Because property taxes are part of your monthly mortgage payment, it is important to get an estimate of what yours would be. Ask your real estate agent or tax office for the rates that apply in the area you want to buy.
You must insure your property to obtain a mortgage. You can get an estimate of insurance costs from an insurance agent or company. Be sure to inquire about special requirements for hazard insurance, such as mandatory coverage for floods, earthquakes, or damaging wind. If you put down less than 20% of your home's value, you also will have to obtain mortgage insurance or take out a second loan, called a piggyback loan, to bring the first mortgage down to 80% of the purchase price. Both alternatives will raise your monthly payment.