One of the most important questions before buying a home is: how much can I actually afford? Banks have specific rules and ratios they use to determine your maximum loan amount, and understanding these can help you set realistic expectations.
The 28/36 Rule
The most widely used guideline in mortgage lending is the 28/36 rule:
- 28% Rule: Your monthly housing costs (mortgage payment, property tax, insurance, HOA) should not exceed 28% of your gross monthly income.
- 36% Rule: Your total monthly debt payments (housing + car loans + student loans + credit cards) should not exceed 36% of your gross monthly income.
For example, if your household earns $6,000/month gross, your maximum housing payment should be $1,680 (28%) and your total debt payments should stay under $2,160 (36%).
Debt-to-Income Ratio (DTI)
Banks calculate your DTI by dividing your total monthly debt obligations by your gross monthly income. There are two types:
- Front-end DTI: Housing costs only (target: under 28%)
- Back-end DTI: All debts including housing (target: under 36%, some lenders allow up to 43%)
A lower DTI means you're a less risky borrower and may qualify for better interest rates.
What Counts as Income?
Lenders typically consider:
- Base salary (gross, before taxes)
- Bonuses and commissions (if consistent for 2+ years)
- Rental income (usually 75% of actual rent received)
- Self-employment income (average of last 2 years' tax returns)
- Alimony/child support received
Hidden Costs Most Buyers Forget
The purchase price is just the beginning. Factor in:
- Property taxes: 0.5% - 2.5% of home value annually
- Home insurance: $1,000 - $3,000/year
- Maintenance: Budget 1-2% of home value per year
- Utilities: Often higher than renting
- HOA fees: $200 - $500/month in some areas
- PMI: 0.5% - 1% annually if down payment is under 20%
The Down Payment Factor
Your down payment significantly affects affordability:
- 20% down: No PMI required, lower monthly payments
- 10% down: PMI required but more accessible
- 3-5% down: FHA/conventional options exist but monthly costs are higher
A larger down payment means a smaller loan, lower monthly payments, and often a better interest rate.
How Interest Rates Affect Buying Power
Interest rates dramatically impact how much house you can afford. For every 1% increase in rates, your buying power drops approximately 10%.
At 6% interest, a $2,000/month payment supports a ~$333,000 mortgage. At 7%, that same payment only supports ~$300,000.
Stress Testing Your Budget
Don't just calculate what you CAN borrow — calculate what you SHOULD borrow. Consider:
- What if interest rates rise at renewal?
- What if one income is lost temporarily?
- Can you still save for retirement and emergencies?
- Will you have money for home maintenance and improvements?
A conservative approach: aim for housing costs at 25% of take-home pay (not gross), leaving buffer for life's surprises.
Use our Home Affordability Calculator to find your comfortable price range based on your specific situation.
