How does a lender determine how much home I can afford?
The primary factor is your debt-to-income ratio, which is a comparison of your gross (pre-tax) income to housing and non-housing expenses. Non-housing expenses include such long-term debts as car or student loan payments, alimony, or child support. Many lenders believe you can afford a house if its price is under 2½ times your household’s annual gross income. Another rule of thumb is that monthly mortgage payments should be no more than 29% of gross income, while the mortgage payment, combined with non-housing expenses, should total no more than 41% of income. The lender also considers cash available for out-of-pocket expenses, such as down payment and closing costs, along with your credit history when determining your maximum loan amount. If you don’t qualify, you may have to buy a less expensive home, pay off some debts or delay your purchase until your income increases.