Key takeaways
- Build the budget from a monthly payment you are comfortable with, then turn it into a price.
- Include taxes, insurance and mortgage insurance, not just principal and interest.
- Leave room for maintenance, savings and the costs that come after you move in.
- Use the lender’s approval as an upper limit, not as your goal.
The question sounds like it has one answer, but it really has two. There is the amount a lender is willing to lend you, and there is the amount you can pay every month without your life getting tight. First-time buyers often hear the first number and treat it as the budget. This guide helps you find the second one, which is usually the one that matters.
What the lender is looking at
The most common yardstick is the debt-to-income ratio, or DTI. You add up all your monthly debt payments, including the future mortgage payment, car loans, student loans and minimum card payments, and divide by your gross monthly income, which is income before taxes and other deductions. The Consumer Financial Protection Bureau gives a simple example: a $1,500 mortgage payment, a $100 auto loan and $400 of other debts make $2,000 a month; on a gross income of $6,000 that is a DTI of 33 percent.
Different loan programs and different lenders set different DTI limits, and they also look at your credit history, your savings and the size of your down payment. That is why two lenders can tell you two different maximums, and why it is worth talking to more than one.
What actually goes into a housing payment
A monthly mortgage payment typically contains up to four parts. Leaving any of them out is the most common way buyers underestimate what a home will cost.
| Part of the payment | What it is | What moves it |
|---|---|---|
| Principal | Paying back the money you borrowed | Loan amount and term |
| Interest | The main cost of borrowing | Your rate, which changes daily while you shop |
| Mortgage insurance | Often required with less than 20% down on a conventional loan | Down payment, loan type, credit |
| Property taxes and homeowners insurance | Costs of owning, usually collected with the payment | Location, home value, local tax rates, disaster risk |
Taxes and insurance deserve extra attention because they vary so much from one town to the next. Two homes at the same price can have very different payments once those are added. Before you fall for a neighborhood, look up its property tax rate and get a rough insurance quote, especially in areas with flood, wildfire or storm risk.
Build your own number
Instead of starting from what you might be approved for, start from your current life. A simple way to do it:
- List your take-home pay for a normal month, not your gross salary.
- Subtract fixed costs that will not change after you buy: car, insurance, childcare, debt payments, subscriptions.
- Subtract savings you want to keep, including retirement and an emergency fund that you rebuild after closing.
- Set aside a monthly amount for upkeep. Owners pay for repairs that a landlord used to cover.
- What is left is the most you want to spend on the full housing payment, taxes and insurance included.
Then work backward. With a rough interest rate, your down payment and local estimates for taxes and insurance, you can turn that monthly figure into a price range. Online calculators help, but redo the math whenever rates move, because the price you can afford changes with them.
Tip: Run your numbers with a rate a little higher than today’s. If the payment still works, a small rate change before you lock will not break your budget.
Cash you need on top of the payment
Affordability is also about cash on the day you buy. You will need the down payment, closing costs and some money that stays in the bank after closing. Lenders often want to see reserves, and you will want a cushion for the first surprise, which in an older house can come in the first month. Our guide to Closing Costs Explained for First-Time Buyers lists what shows up at the closing table.
Down payment: bigger is not always better
A larger down payment lowers the loan amount, the monthly payment and, on a conventional loan, can remove the need for private mortgage insurance. But emptying every account to reach 20 percent can leave you with no reserves at all. Private mortgage insurance protects the lender, not you, and on many loans you can ask to cancel it once the balance is scheduled to fall to 80 percent of the home’s original value, with automatic cancellation at 78 percent if you are current. Sometimes keeping cash and paying mortgage insurance for a while is the more comfortable choice.
When the lender’s number is higher than yours
This happens often. A lender may approve you for more than your own budget suggests, because their formula does not know about your childcare, your travel or the savings you want to protect. Treat the approval as a ceiling. Shopping at or below your own number keeps you flexible when you negotiate, absorbs a higher tax bill than expected, and keeps homeownership from crowding out everything else.
Once you have a range, the next step is a preapproval, which turns your estimate into a letter you can show sellers. See Getting Pre-Approved for a Mortgage: What It Means and How to Do It Well.