In addition to choosing the right property, one of the most important steps to navigate as a homebuyer is understanding the financial requirements needed for a mortgage. This is especially important for first-time homebuyers.

When trying to figure out the right time to explore homeownership, there can be conflicting answers to the critical question, "How much income do I need to buy a house?" To help simplify and clarify this answer, we will explore the several factors that can impact affordability, and the decisions to make as a homebuyer as a result.

The income required for buying a home can be influenced by several factors: the home’s price, interest rates, the type of loan you choose, and the size of your down payment. We will explain common rules such as the “30% rule” and look at debt-to-income or “DTI” as lenders say. Together, you should have a clearer understanding of how much income is needed to buy a home.

Factors That Affect How Much Income You Need

When calculating how much income you need to buy a house, it's essential to consider various factors, including the home's price, loan type, and personal financial situation. The amount of income needed is directly related to how much your mortgage and housing-related expenses are. Let’s explore the factors that influence those expenses.

Home Price  

The price of the home you buy is one of the primary considerations in how much income you’ll need. Homes in different regions and markets can vary significantly in price, so your location has a large impact on affordability. As an early step, examine listings in your target area that align with the type(s) of home you are considering.

Down Payment

A down payment is the upfront amount you pay toward the purchase of your home. Some loan programs, such as VA and USDA loans, may not require a down payment for eligible borrowers, while FHA or conventional loan programs require at least 3% down.

Typically, to qualify for a conventional loan without an added private mortgage insurance (PMI) cost factored into the monthly mortgage payment, a down payment of 20% is needed.

The more you can bring as a down payment, the smaller the size of the loan and overall borrowing costs you would be paying each month. A smaller monthly mortgage payment means less income needed to afford and buy your home.

Interest Rate

Mortgage rates fluctuate over time, and they have a significant impact on how much income you need. If you are looking to buy a home at a time where interest rates are lower, your monthly mortgage payment will be lower due to the decreased cost of financing the home. For example, buying a home when you can qualify for a mortgage with a 6% interest rate will cost less monthly than when your potential mortgage is at 7% interest.

Loan Program

Different types of loans come with different qualification requirements, costs, and structures. Conventional loans may typically require a higher credit score and a larger down payment compared to FHA loans, which are more lenient, but you may also find a variety of repayment options between the two. Some government programs have mortgage insurance that lasts the life of the loan, and others require an up-front “funding fee”. Borrowers with different credit profiles may see better interest rates or lower costs on different loan programs.

Repayment Length

In addition to the loan program, the loan term also affects the mortgage payment being made. Longer terms, such as a 30-year mortgage, will likely cost more in interest over the life of the loan but result in lower monthly payments spread over a longer period. The greater affordability of the monthly mortgage payments is the primary advantage of a 30-year mortgage over shorter mortgages such as those with a 15-year loan term.

Whether you are looking for a standalone single-family home or condominium, bringing the minimum down payment required or at least 20% down, looking for a 30-year loan or a quicker repayment term, or applying with a strong credit profile or one that is just being established, knowing where you stand is a good initial step. Next, it is important to figure out how much of your income can safely, reliably be dedicated to your housing-related expenses.

“30% Rule” and Others: What Is the Most Useful Guide?

Even if you have just begun to explore homeownership, it is likely you’ve heard of the "30% rule" before: It’s often suggested that no more than 30% of your monthly gross income should be spent on housing costs. By “housing costs”, this means monthly mortgage payment, property taxes, homeowner’s insurance, along with HOA fees and private mortgage insurance (if applicable to your loan). This rule has been propagated as a standard budgeting guideline for many years, along with variations such as the 25% net income rule, 28% rule, and even a 35% pre-tax / 45% post-tax comparison to all debts. Regardless of the variation considered, it may serve as a useful as a rough benchmark for housing affordability, but there is much to consider.

The benefit of the 30% rule is that it is easy to understand and apply. It’s a straightforward way to estimate whether you can afford a home given your income. By limiting housing costs to 30% of your income, this guide is used to help ensure you have enough left over for other living expenses, savings, and emergencies.

However, the 30% rule does not take into consideration your existing debts like car loans, student loans, credit cards, or court-ordered payments into account. A homebuyer who can find a home with payments within the 30% rule may still have difficulty qualifying for or affording a home loan if they carry a significant amount of debt. Additionally, general cost-of-living can vary alongside housing prices and are not considered in this rule. If your target area has a higher cost of living, the 30% rule may be underestimating how far your income must stretch. In short, the biggest limitation of the 30% rule is that homeownership involves more than just paying the mortgage. Maintenance, utilities, HOA fees, and home improvements all factor into the total cost of owning a home as well.

Overall, the “30% Rule” is a fair starting point when you have a limited picture, but it should not be used as the sole guide when deciding how much income you need for a home that is in your budget. This is where debt-to-income or “DTI” comes into consideration.

Understanding Debt-to-Income (DTI) Ratio

DTI ratio plays a crucial role in the mortgage qualification process. Lenders use this to assess your ability to manage monthly payments and repay your debts. It is calculated by dividing your total monthly debt payments by your monthly gross income. 

For example, consider a homebuyer in this scenario:

• Monthly debt payments (including mortgage): $2,000
• Gross monthly income: $6,000
• DTI ratio = $2,000 ÷ $6,000 = 0.33 or 33%

33% of this homebuyer’s income monthly gross income is needed to cover all of their debts (mortgage, credit cards, student loans, auto loans, to name a few). Lender and loan program requirements vary, a DTI of 43% or lower is generally preferred. The lower your DTI ratio, the better your chances of securing a loan with favorable terms, as a lower DTI shows less risk and that you have more monthly cushion to cover your mortgage and other expenses. Some may accept higher DTI ratios, especially with strong credit or a large down payment.

It is worth noting that the DTI limits that a mortgage lender or loan program set attempts to protect against exceeding the maximum. In many cases, the amount of income you need for an affordable payment without stress or pressure is enough income to keep you as the homebuyer comfortably below the DTI limit.

Considering Your Income

Regardless of whether you are qualifying for a mortgage or just simply planning ahead, the pattern of your income is also important to consider. Lenders are looking for a stable work history with little or no recent gap, along with income levels that are stable (not intermittent or fluctuating widely) and likely to continue.

When calculating different types of income sources, the mortgage lender must consider the degree to which that income varies. Hourly or salary income may be more easily understood when budgeting a mortgage payment, while seasonal income, commissions, overtime, self-employed income, and even payments outside of typical employment such as alimony, Social Security, and military allowances require closer evaluation to determine how much income is reliable, stable, and likely to continue.

Building a Road Map with a Mortgage Lender

While considering the factors and guidelines above can give you a general idea of how much income you need to buy a house, the best route is to speak with a lender early in the process. A reputable and reliable lender such as Union Home Mortgage will assess your unique financial situation, including your income, credit score, down payment, and debts, to help you determine how much home you can afford.

Through a process known as preapproval, mortgage lenders will calculate your borrowing power by examining your income along with pulling a credit report to examine your credit history and current debts, in order to give you a clearer picture of your potential home purchase. The preapproval process will help you find what loan programs you are eligible for and what home price is at a level that can be supported and approved at your level of income. Not only does preapproval help you set realistic expectations, but it can be a valuable tool in a competitive housing market.

The information provided here is for informational purposes. When interest rates and loan program information are included, it is for illustration purposes only and not a solicitation or quote for services. This is not an advertisement or loan estimate. Current interest rates, loan programs and qualification criteria can change at any time. If you have questions or need assistance, we can be reached using the contact information above.