Mortgage lenders use a fairly standard formula to calculate the size of the loan you can qualify for based on your income and long-term debt. Prospective home buyers with an excellent credit rating or a large down payment may find that their lender is open to some negotiation on the amount, although they will still use the standard formula as a starting point.
The amount you can borrow for your mortgage depends on various factors, including your income, your debts, the current interest rate and the type of mortgage you want.
Determining Your Gross Income
The first step in figuring out the size of the mortgage you can borrow is to determine your gross income, or how much you earn before taxes. According to Realtor.com, income may include more than just your salary. You can use any recurring earnings that you can document or that show up on your tax returns, such as alimony, income from investments or even lottery winnings. No matter how much you make from babysitting your neighbor’s child, however, you cannot use those earnings unless you declare them on your taxes.
Calculate your monthly earnings by dividing your annual earnings by 12 or multiplying your weekly earnings by 4.3.
Housing Expense Percentage of Income
Most mortgage lenders limit the amount of income you can spend each month on your housing expense to 28 percent. Your total housing expense includes your mortgage principal and interest as well as the taxes and insurance on your home. If you aren’t sure what your property tax and insurance costs will be, figure that roughly 15 percent of your payments will be allocated to those expenses.
With an annual income of $75,000 per year, or $6,250 per month, your total housing expense can be as much as $1,750 per month, with $1,487.50 allocated to your mortgage principal and interest payment.
Monthly Debt Percentage of Income
The amount of recurring debt you have will also impact the amount you can borrow. Conventional mortgage lenders will allow a combined total monthly expense of up to 36 percent for housing and recurring debt payments combined. The 36 percent is split up, allowing 28 percent for your housing costs and an additional 8 percent for recurring debt, which includes things like student loans, car loans, credit cards and alimony or child support payments.
If you have an income of $75,000 per year, most mortgage lenders would allow you to have up to $500 each month in payments toward these debts.
Using a Mortgage Affordability Calculator
Once you have worked through the income and debt numbers, use an online mortgage calculator to determine the size loan you will qualify for. The amount will depend not only on your income, but also on the current interest rate and term of the loan. For example, if you make $75,000 per year and the current interest rate is 4 percent, you should qualify for a $300,000 mortgage if you’re taking out a 30-year mortgage, or a mortgage of roughly $200,000 if you decide to go with a 15-year mortgage.
FHA and VA Loan Guidelines
While the same type of process applies when determining the size mortgage you will qualify for, FHA and VA loans use different income and debt ratios. The FHA allows up to 31 percent for your monthly housing expense and 43 percent in total for housing expense plus recurring debt. The VA does not differentiate between housing expense and recurring debt payments. It simply allows a total of 41 percent for both expenses.
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