While shopping around for your dream home, you may start to wonder, –how much mortgage can I afford? Assuming you are a responsible home buyer, you will immediately feel the need to determine exactly how much home you can actually take on.

But what exactly goes into the cost of a mortgage? Below is a breakdown of what a mortgage constitutes, what lenders use to determine your mortgage, and how you can prepare to pay it.

What is a mortgage?

A mortgage is the amount of money you will need to pay incrementally to own a home. Before closing out a deal on a home, homebuyers will need to secure a mortgage loan, which is another way of saying a “home” loan.

Budgeting for your mortgage

Before jumping into your home buying journey, it is paramount that you properly budget your current expenses. Budgeting is how you will ultimately determine the mortgage you can afford. 

For instance, the down payment amount you decide to pay will be crucial in affecting your overall mortgage. With conventional mortgage loans, it is recommended to pay as high as 20% of the purchase price of the home because this often waives the expensive insurance fees and gets you the best mortgage rate

However, it is not uncommon for lenders to accept down payments as low as 3-5% of the purchase price. Other loan types, like the Federal Housing Administration (FHA) loan, are government-insured loans that accept as low as 0-3% down payment.

With the down payment in mind, the importance of budgeting becomes much more apparent. Unless you are being gifted the down payment amount, you will need to save for this money. Cutting costs, in general, is advised anyway, because buying a home often becomes more expensive than initially perceived.

PITI

Mortgages are usually paid on a monthly basis, similar to other types of loans like car loans or student loans. What comprises the mortgage payment are the following factors: the principal, interest, taxes, and insurance. Collectively, these are referred to as PITI.

Principle. That is the overall size of the loan you will be taking out, equal to the purchase price of the home.

Interest. A mortgage rate is essentially the interest you will pay on your loan. These rates are often rolled into your monthly mortgage payments. Different lenders offer different mortgage rates depending on your credit profile, location, and the state of the housing market. Mortgage lenders will often have a mortgage rate calculator on their website.

Taxes. Property taxes vary depending on the state and county in which you are buying your home, and you can look this info up online. On average, property taxes are around 2% of the value of the property.

Insurance. Homeowners insurance is required — to varying degrees — for all homeowners. The insurance covers things like stolen property and catastrophic events like floods or fires. Additionally, most loans come with mortgage insurance that typically costs between 0.5-1% the amount of your loan. If paying 20% or more down payment on a conventional loan, however, the mortgage insurance can be waived.

How to qualify for a mortgage

As you’re budgeting, keep in mind what exactly it is that lenders are looking for when determining how much mortgage they think you can afford. An important metric to think about is the Debt-to-Income ratio (DTI).

DTI is a metric used to gauge whether or not you can afford a mortgage by comparing your gross monthly income to the total amount of money you owe between all of your accounts. Total money owed is all of the payments you make per month to pay off debts like car loans, student loans, and credit card payments. To calculate your DTI, take your total monthly debt payments and divide it by your gross (pre-taxed) monthly income, resulting in a percentage.

Lenders are looking for a DTI that is less than 43%, but preferably less than 36%. If you’re calculated DTI is any higher, it’s likely you will immediately be denied a mortgage.

Another way lenders assess how much mortgage you can afford is by using the 28/36% Rule. Similar to the DTI, the 28/36% Rule suggests that individuals should be spending no more than 28% of their gross income on housing, and no more than 36% on debt. 

Use a Mortgage calculator

One way to understand how much mortgage you can afford is to use a mortgage calculator. You can find these calculators built into many websites across the internet, such as the website of a mortgage lender. 

Online mortgage calculators will require you to do some of the work beforehand. You’ll need to have an idea of what the expected price of the home will be, for one, as well how much of a down payment you want to pay. Once you plug the numbers in, you will receive an estimated monthly payment. Cross-reference this estimated monthly payment with your DTI and mortgage rate estimation to obtain the best understanding of how much mortgage you can afford.

Other things to keep in mind

There are several additional expenses you need to keep in mind when calculating how much mortgage you can afford. What lenders don’t include in your mortgage are the general costs of living. Some things to consider are:

Gross vs. taxed income. As mentioned above, lenders use your gross monthly income to determine your DTI. To help hedge against the unexpected costs of living, it may be advantageous to run your DTI calculations using your income after it’s been taxed for the sake of frugality.

Closing costs. Finalizing the sale of home comes with what are known as closing costs. These include the application fees, credit reports, consultations, and walkthroughs that are all necessary steps in purchasing a home. Closing costs can sometimes near an additional $8,000 when all is said and done.

Maintenance. Although home inspections are a necessary part of the home-buying process, there is always the chance that unforeseen maintenance will need to be done.  

Utilities. Internet, waste management, electricity, and other services are often forgotten when calculating the cost of living.

HOA fees. Upper-end suburban neighbors and gated communities often have Home Owners Associations (HOA) which act as governing bodies within these communities. In order to uphold HOA standards, a fee is usually required. 

Furniture and decorations. Obviously a home just isn’t a home without the right set of furniture in decorations. Don’t underestimate the cost of these housing add-ons when determining how much mortgage you can afford.

Summary

So how much mortgage can I afford? By considering your down payment and PITI in reference to your DTI, you can get a pretty accurate estimate of what kind of home you can afford. Budgeting is essential to making sure you can save for a down payment and afford the mortgage payments once the home is bought. Aim for staying within the 28/36% Rule to maximize your chances for loan approval. Ultimately, the mortgage lender will be the one to decide how much of a loan you can borrow, but it’s best to do the math yourself first.