How much can I borrow for a home loan, with my income?

Reader question: “We make about $140,000 per year, between the two of us. We are planning to buy a house in 2013 and will need a mortgage to help pay for it. How much can I borrow for a home loan, based on these income numbers? How do lenders decide where to draw the line, as far as the actual amount they will lend to us?”

There are two ways to approach this. You can approach it from your perspective, by focusing on the affordability of the loan. Or you can approach it from the lender’s perspective, by focusing on the minimum qualification standards for the loan. In a previous article, I covered this question from the borrower’s side, with an emphasis on affordability. So this time around, let’s look at it from the lender’s side…

How Much Can I Borrow for a Home Loan?

How much can I borrow for a home loan? This is one of the most common questions we get from home buyers, especially those who are purchasing their first home. Here are the basic steps involved:

1. Create a housing budget to determine what you can afford to spend each month on mortgage payments.
2. Calculate your debt-to-income (DTI) ratio by dividing your total recurring debts by your gross income.
3. If you don’t want to do the math yourself, you can do a Google search for “debt to income calculator.”
4. Apply for a home loan, or get pre-approved by a lender.
5. The lender will probably limit you to a certain DTI percentage. Forty-three percent is a common cap these days.

Getting pre-approved is one way to figure out how much you can borrow for a home loan. During the pre-approval process, the lender will review your current debt and income situation to determine the maximum amount they are willing to lend you. If you’re not ready to talk to a lender yet, you can do some of the math on your own. You can use a debt-to-income ratio of 43% as a general rule of thumb.

The 43% DTI Rule of Thumb

These days, many lenders use 43% as a total debt-to-income limit. Under this rule, your combined monthly debts would not be allowed to exceed 43%. In this context, your “combined” debts include your mortgage payment and all other recurring debts (credit cards, car payment, student loans, etc.).

Step 1: Add Up Your Non-Housing Debts

So, how much can you borrow for a home loan, with an income of $140,000 per year? Let’s use the 43% rule of thumb to break it down. Keep in mind this is just a rough estimate, for educational purposes.

• Gross monthly income: $11,600 ($140,000 ÷ 12)
• Total monthly debts without mortgage: * $2,000

* In this scenario, the $2,000 debt level does not include any housing expenses — no mortgage, and no rent. We will get to that in step 2.

If we divide monthly debts by monthly income in this scenario, it comes out to 17% (2,000 ÷ 11,600 = .17, or 17%). This is well below the 43% limit mentioned above, because it doesn’t include mortgage payments yet. But it will soon. The purpose of step 1 is to see how much room you have for a monthly home loan payment, based on DTI limits.

Step 2: Add in the Mortgage Payment

Now we need to add mortgage payments into the mix. We are trying to measure the combined or “back-end” debt ratio. This is the one lenders are most concerned with. The back-end ratio includes all of your recurring debts, including the monthly mortgage payments. So, if you want to know how much you can borrow for a home loan, you’ll want to focus on the back-end ratio.

There are several ways to go about this. The easiest way is to use a mortgage calculator to break down the total loan amount into estimated monthly payments. You could then add this amount to your other monthly debts ($2,000 in our hypothetical scenario).

Here’s how it might play out:

• Home loan amount = $400,000
• Monthly payments = $1,570
• Other monthly debts from step 1 (car payments, credit cards, personal loans) = $2,000
• Total monthly debts, including mortgage payments = $3,570
• Gross monthly income: $11,600

In this scenario, the combined or back-end DTI ratio is 30% (3,570 ÷ 11,600 = 0.30, or 30%).

So what have I done here? I want to know how much I can borrow for a home loan. So I’ve added up all of my recurring monthly debts, including my estimated mortgage payments. I then divided this number by my gross (pre-tax) monthly income, to come up with my back-end DTI ratio.

My back ratio came to 30% — well below the 43% limit used by most lenders these days. So there’s a good chance I could borrow $400,000 for a home loan, as long as my other qualifications checked out. In fact, I could probably borrow quite a bit more than $400,000, before raising any red flags on the DTI front.

Just remember that home loan affordability and approval are two different things. The 43% rule relates to mortgage approval. Affordability is something else entirely, and you can learn about it here.

Disclaimer: This article answers the question, How much can I borrow for a home loan? This article includes general rules of thumb, estimations, and assumptions. None of this is written in stone. We have used real numbers and current lending standards as much as possible, to create a realistic scenario. But there are exceptions to every rule. The only way to find out how much you can borrow for a home loan, with any level of certainty, is to speak to a mortgage lender.