Buying a house is a huge step in building lasting wealth. Cars, boats, and weekends in Vegas are all expensive, but they don’t retain their value very well. Buying a house is a way to improve your standard of living and start investing in assets that will retain value, possibly for generations. How much can you afford to spend?

What’s the 28/36 rule, and should I follow it?

The 28/36 is a rule of thumb for what percent of your income should go to debt payments. According to the rule, you shouldn’t spend over 28% of your income on mortgage payments and 36% on total debt payments (including the mortgage, car loans, credit cards, student loans, etc.). 

That means if you make $200,000 per year—$16,667 per month—your mortgage payment shouldn’t be more than $4,667. 

If you assume your rate is 6% per year and a 30-year mortgage term, that means the maximum mortgage amount would be about $778,000, with a $222,000 down payment you could get to a million-dollar purchase. 

How do I calculate how much house I can comfortably afford?

Online calculators will help you figure out what rate may be available based on your credit score and what the payment would be with that rate and various down payment amounts and terms. This one at NerdWallet is great, and this one at Bankrate will help you break down each individual line item. 

What factors do lenders consider to determine loan amounts?

Mortgage lenders will analyze three factors to underwrite the loan. These factors not only determine what the amount of the loan can be, but also whether the bank feels safe with you as a borrower.  

Credit history

Most people know what a credit score is, but fewer know the extent that a full credit report goes into with their credit history. The credit report shows every single loan or credit line you’ve ever had along with the current balances, a history of every payment, and if any payments were greater than 30 days late. The report also shows if you’ve had any judgments filed against you in court, bankruptcies, other last names, and historical addresses. 

Lenders love credit histories that don’t have a blemish. No late payments, no delinquent accounts, no judgments, low revolving balances. Those types of loan applications are rare. A credit report with a few late payments or even a judgment or two is fine, as long as you can write a letter explaining what happened. 

Debt-to-income

Next, the lender determines whether your current income is high enough to support the debt payments. Debt-to-income (DTI) is the ratio of your total debt payments, including the new mortgage payments, to your income. It is the ratio you calculate in the 28/36 rule. 

Some lenders will go up to 57% for DTI depending on whether you can get the mortgage guaranteed by a government program, but for conventional mortgages the max is usually around 50%. 

That amount is far more than the 28/36 rule of thumb so if you follow that you won’t have a problem getting through this stage of underwriting. 

Collateral analysis 

Finally, the bank needs to cover its ass. If the borrower defaults on the loan, the lender will repossess the collateral to make itself whole.

To analyze the collateral, the lender will order an appraisal from a third party to determine an unbiased valuation of the home based on comparable sales in the area. Banks want a loan-to-value of 95% minimum (meaning the loan amount is 95% of the value of the home) or around 80% for Jumbo loans (loans over $647,200).

Also, the bank will hire a title company to ensure that the seller has title to the property, and that you filed the correct documents to keep the chain of ownership going. You will likely close the loan with a title officer.  

What else do I need to know about buying my first home?

The biggest change for most first-time homebuyers I’ve met is the lack of a maintenance guy to call. When you’re in an apartment and the drain gets clogged or the HVAC stops working, there’s always someone to call and always someone else to pay to fix things.

When you own your house, you have to find someone to fix things, and you have to pay for it. Houses are depreciating assets. The roof, appliances, toilets, outlets, and every other part of the house will wear out eventually and need to be replaced. 

If you’re working on a budget to stretch and afford a house that might be a little out of your price range, make sure you can also afford any unexpected maintenance expenses.  

Location, location, location

Buying your first home introduces a lot of stress to your life. You have to fix things, cut the grass, and make loan payments. But it is the most reliable way to start building your assets. The key is to be conservative. Get your feet wet and find a place where you like to live.