How to Calculate Your Mortgage Payment

Buying a home is a rewarding milestone, but it doesn’t come cheap. After careful budgeting and penny-pinching to save for what’s likely the biggest purchase you’ll make in your lifetime, you may be wondering: How much mortgage can I afford?

A lot of number crunching goes into answering that question — from you and from your lender. As a rule of thumb, lenders suggest that prospective home buyers can finance a loan that’s about two to two and a half times their gross annual income.

For example, if a couple earns about $200,000, that means they should be able to afford a mortgage of at least $400,000. But this black-and-white calculation doesn’t take into consideration other factors involved in determining how much that couple can afford, such as their individual financial and personal circumstances.

How to Qualify for a Mortgage

When it comes to qualifying for a mortgage there are a lot of factors that you need to consider. Let’s take a closer look at some of these factors to help you determine how much mortgage you can realistically take on, as well as how much you may qualify you for in a loan.

Tally Your Income, Debts and Potential Monthly Payment

For due diligence’s sake and for your own peace of mind, start by running your own numbers so you can decide, independently, how much you can comfortably afford without becoming house poor.

House poor is when the majority of your income is being funneled into the cost of your home, leaving little income left for the rest of your household budget. Some people even end up going into debt month-by-month to keep up with their mortgage payments.

To determine how much mortgage you can afford, add up your monthly income from all revenue streams — your job, rental earnings, investments, etc. Put this number on your budget.

Next, tally your monthly payments to credit cards, student loans or other lines of credit. Consider all of your monthly non-housing expenses too —childcare, car payments and fixed expenses such as your cell phone, internet and any subscriptions.

Once you subtract your expenses from your income, what’s left over?

This amount can go toward your mortgage payment, homeowners insurance, property taxes and other costs that come with homeownership. But you should tread carefully here. While you may have a large sum left over, you shouldn’t max out your income on your mortgage — you need wiggle room to factor in unforeseen expenses and to contribute to a slush fund.

You probably have other ongoing priorities too, such as saving for long-term goals like retirement or short-term goals like a family vacation next summer. You don’t want all of your income to go toward your mortgage, debts and bills, ignoring these other financial goals.

Determine the Percentage of Gross Income You Can Afford

Once you know your complete financial picture, now you are able to determine what percentage of your gross income you can comfortably put toward a monthly mortgage payment. Your mortgage payment is broken down into four components: the principal, interest, taxes and insurance (property insurance and private mortgage insurance, if needed), referred to as PITI.

Personal finance experts suggest allocating no more than 25 percent to 30 percent of your gross income to PITI. Twenty-eight percent is typically the magic number here. This is important because while lenders may be willing to grant you larger loans, which you could end up defaulting on.

Running the numbers on how much home you can afford is a great exercise as it preps you for precisely what lenders will evaluate as they decide how much you qualify for in a loan.

This is also a pivotal step because it factors in your individual needs and lifestyle. While lenders and online affordability calculators use a formulaic approach in deciding how much you can afford, only you’re attuned to how much you spend on travel or eating out, and how much you’re genuinely willing to reel in discretionary spending to make your housing dream come true.

How Lenders Determine Your Mortgage Loan

It’s safe to say there are no sweeping approaches to how lenders determine how much mortgage a borrower can afford, but they look at nearly identical criteria across the board. Gaining insight into what your lender thinks you can take on and how they decide this can help you build your case.

To ensure you are a star candidate for a loan, keep the following lender priorities in mind.

Your Down Payment

How much skin do you have in the game? Your down payment is the lump sum payment that you make with cash or liquid assets when you purchase your home.

Most lenders require that homebuyers put down 20 percent of their home’s purchase price to qualify for a conventional loan. This is a hefty commitment for many home buyers, so if you don’t have enough saved up or don’t want to put all of your savings into your down payment, don’t fret.

There are mortgage loan options that accommodate smaller down payments. However, the bigger the down payment, the smaller the loan — which means less risk on the part of lenders.

Your Credit Score and Creditworthiness

Similar to when you apply for a credit card or a line of credit, your lender will run a background check on you so you’ll want to make sure your financial ducks are in a row. They’ll consider your gross income, how stable your income is, any Social Security benefits and, most critically, your credit score.

Your credit score and credit history are incredibly telling — have you defaulted on loans before or are you consistently punctual with payments?

Applicants with a low credit rating could end up paying higher interest rates because they aren’t seen as trustworthy to lenders. Before you apply for a loan, pull your credit reports from Equifax, TransUnion and Experian to make sure there aren’t any surprises and you can address any issues.

Lenders reward those with the highest credit scores, minimal debt and sizeable down payments with the lowest interest rates. It’s worth your while to get yourself in the best financial health and start repairing your credit — it could make a massive difference in how much you end up paying in interest.

Your Debt-to-Income Ratio

Just as we advised calculating all of your debts as part of your financial picture, lenders are doing the same to determine your debt-to-income ratio or how much of your income is being dedicated to your debts.

Lenders tally up all of your liabilities, including your credit card payments, auto loans, student loans, lines of credit and child support and consider how much you need to commit to each of these debts.

If servicing your debt takes up more than 36 percent of your gross income, your lender may be wary that your income is not sufficient to cover all of your debts. This is why it’s important to tackle your debts as much as you can before you approach lenders about buying a home.

It’s worth noting that debt-to-income ratio doesn’t include your regular monthly expenses like your bills and subscriptions.

Understand the Terms of Your Loan

If you’re committing to homeownership, you’re about to get closely acquainted with common mortgage terms, from interest rates to amortization periods.

The terms of your loan are factored into the equation lenders use, too. For example, if you are making a sizeable down payment on a $200,000 home, you’ll likely secure more favorable loan terms (fixed interest rate, loan type, length of loan) compared to someone wanting to put 5 percent down on a $700,000 home.

Ultimately your lender needs to know that you can handle your loan and its terms based on your income, assets and liabilities.

The Role of Online Mortgage Calculators

Online mortgage calculators are readily available to help you do the clunky math in determining how much you can conventionally afford. They’re a great jumping-off point as you gain an understanding of what’s factored into home affordability equations.

In the most bare bones mortgage calculators, you simply plug in your income, your down payment, your monthly debts and your loan length and the calculator will spit out a number of how much mortgage you can afford. Others are more detailed, asking for your monthly utilities, dependents, entertainment budget, housing expenses and travel and miscellaneous spending.

How Accurate are Online Mortgage Calculators?

Take each of these calculators with a grain of salt, though. Because they’re calculating the mortgage payment based on the wider population, they don’t consider your individual circumstances. This includes items such as how stable your income is, if hoping to expand the family or if you’re aging and needing to move into part-time work or facing medical expenses or higher health insurance premiums.

Personal finance counselors also note that these calculators look at your gross income and don’t consider paycheck deductions for taxes, employee benefits and other programs.

These calculators – and what your lender ultimately qualifies you for – don’t account for your personal comfort with debt, either. Some people sleep easier at night knowing their mortgage will be manageable and malleable should they face a job loss, leaky roof or other unforeseen expenses.

Others make the mistake of qualifying for a generous loan and start shopping for a house on the upper end of what they’ve just qualified for. Remember, just because you qualify for a certain amount doesn’t necessarily mean you can afford it.

Don’t forget about the other expenses that come with homeownership, especially if you’re a first-timer. You’ll need to buy new furniture, home décor and potentially expensive appliances, such as a refrigerator or dishwasher. You’ll also incur closing costs on the purchase, which are up to 5 percent of the loan amount.

And just as renters do, you need to factor in an emergency savings net to cover three to six months’ worth of expenses.

The Bottom Line on Mortgage Payments

Do your homework with your own number crunching and play around with various online calculators to get a feel for what you may be able to take on in a mortgage. Shop around with various lenders to see what they offer. You can even prequalify for a loan, which isn’t set in stone or guaranteed, but provides you with an idea of the types of loans lenders could offer you and how much mortgage they think you can afford.

Now, it’s time to get out there and look at houses!