Money matters: Factors affecting mortgage affordability

Mon Mar 06 2023

A woman in her new living ome surrounded by moving boxes and checking her smartpone

Making sure you can afford your mortgage payments is just as crucial as finding a home you and your family will love – if not more so! The size of your loan is a big part of your total cost of ownership, but so is the mortgage rate you lock in, as well as other house costs like property taxes and insurance. Plus you may have additional homeowners fees and private mortgage insurance premiums to pay.

Let’s take a look at several factors that can impact mortgage affordability, starting with the 28/36 rule for how much debt you should have.

What is the 28/36 rule?

The 28/36 rule is a formula for determining how much debt an individual or household should take on. Basically, it states that a household should spend no more than 28% of its gross monthly income on total housing costs and 36% on debt, like credit card and auto loan payments.

Lenders frequently use the 28/36 rule to decide whether or not to offer borrowers credit. The idea is that debt loads higher than the 28/36 limits will likely be difficult for a person or household to sustain and may eventually result in default.

How does the 28/36 rule impact your home-buying budget?

Most traditional lenders set a maximum household expense-to-income ratio of 28% and a maximum overall debt-to-income ratio of 36% when using the 28/36 rule to evaluate your creditworthiness. To do this, they may ask about housing costs and comprehensive debt accounts in the credit application.

Each lender creates their own standards for housing debt and total debt as part of its underwriting program. But the general idea is that the borrower’s living expenses (e.g., rent, mortgage payments) are at most 28% of their monthly or yearly income. The borrower’s entire debt obligation can’t be higher than 36% of income.

For example, let's assume that a person earns $5,000 monthly. If that person follows the 28/36 rule, they might set aside $1,000 monthly for their housing costs and mortgage payments. This would leave an additional $800 available for paying back other kinds of loans.

An easy tip to reduce the debt-to-income ratio is to consolidate multiple debts and clear your financial obligations before applying for a mortgage. When you consolidate multiple debts through a debt consolidation program, your monthly payments get reduced, and it becomes easier for you to get out of debt.

What is a credit score?

Credit scores are three-digit numbers that were created to help companies predict the credit behavior of businesses and individuals. The companies that develop credit scores typically look at factors such as:

  • On-time payment history.
  • Amount of unpaid debt.
  • Amount of available credit being used.
  • Number and type of open loan accounts.

How does your credit score impact your home-buying budget?

Mortgage lenders also look at your credit score and credit report when deciding whether you qualify and when calculating your interest rate. They have several different credit scores to choose from, but lenders are more likely to use your FICOⓇ Score.

The general rule is that a better credit score gets you a lower interest rate. Many mortgage lenders will only pay attention to your application if your score is at least 620. Even when the down payment is just 3% to 5% of the purchase price, a borrower with excellent credit is given the best terms. A borrower with a 3% down payment and a bad credit score (659 or lower), on the other hand, pays more throughout the life of the loan.

Credit Score range

Credit score range

Range Remarks
800-850 Excellent
740-799 Very good
670-739 Good
580-669 Fair
300-579 Poor

It is legally feasible to get a loan from the Federal Housing Administration (FHA) with a 500 credit score. However, you’ll probably have to meet other requirements, such as having:

  • A Social Security number.
  • No bankruptcies for the past two years.
  • No short sales, foreclosures, or deeds in lieu of foreclosures for the past three years.

Additional criteria may apply, and you should note that you may end up paying a lot more money than you would with a different type of loan.

What other factors influence how much house you can afford?

How much house you can afford is determined partly by your:

  • Monthly income.
  • Cash reserves for a down payment and closing costs.
  • Monthly expenses.
  • Credit history.

These all influence your budget and how much of a down payment you can make. Your down payment varies based on the type of loan you take out, and it plays a significant role in determining your mortgage affordability.

A larger down payment can result in a lower interest rate and more rapid home equity growth. On the other hand, a lower down payment can mean you end up with higher costs overall.

For example, you may be required to pay for private mortgage insurance (PMI) if your down payment is less than 20 on a traditional loan. That can increase your monthly mortgage payment by the annual cost of PMI – usually around 1% of your outstanding loan balance. Once your remaining balance reaches 80% of the initial loan amount, you can ask to have PMI removed.

That said, there are ways to buy a home for no money down. Both the US Department of Veterans Affairs and the US Department of Agriculture have loan programs that don’t require a down payment. Plus, there are loans that only ask for 3% to 5%, like an FHA loan that needs just a 3.5%.

Other factors that influence your house-buying budget are:

  • Interest rates. The interest rate imposed on your mortgage affects its affordability. More often than not, homebuyers with high credit scores qualify for cheap mortgage interest rates, though lenders also consider your income and other loans.
  • Property taxes. Buying a home means taking on the associated tax obligations, so you want to account for property taxes in addition to your mortgage payment. That bill can be very different depending on the value and location of your property.
  • Homeowners insurance. Getting home insurance protects you from financial losses should you experience a catastrophe. Several factors impact premiums, but the average is just over $1,200 per year.
  • Closing costs. Closing is the last step in buying a home, and there are usually closing costs that must be paid at that time. These can range from 2% to 5% of the price of the house.

The bottom line

Ultimately, you want to think carefully about how much house you can afford. If you base your decision solely on how much you want to spend each month on your mortgage payments, you may end up short.

Instead, look at your whole financial situation. That starts with whether or not you can afford a mortgage as well as the other costs that come with homeownership. After you've done all of that, it's time to start looking for the perfect home.

About the author

Lyle Solomon has extensive legal experience, in-depth knowledge, and experience in consumer finance and writing. He has been a member of the California State Bar since 2003. He graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, in 1998 and currently works for the Oak View Law Group in California as a Principal Attorney.


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