Lenders will look at your current budget (income, assets, and debts), and how much you would like to pay for the down payment and calculate two ratios to determine how much they are willing to lend.

Debt-to-income ratios

To determine your maximum mortgage amount, lenders use guidelines called debt-to-income ratios. They are simply percentages of your monthly gross income (before taxes) that is used to pay your monthly debts. Because there are two calculations, there is a "front" ratio and a "back" ratio and they are generally written in the following format: 33/38.

The front ratio is the percentage of your monthly gross income (before taxes) that is used to pay your housing costs, including principal, interest, taxes, insurance, mortgage insurance (when applicable) and homeowners association fees (when applicable). The back ratio is the same thing, only it also includes your monthly consumer debt. Consumer debt can be car payments, credit card debt, installment loans, and similar related expenses. Auto or life insurance is not considered a debt.

A common guideline for debt-to-income ratios is 33/38. A borrower's housing costs consume 33 percent of their monthly income. Add their monthly consumer debt to the housing costs, and it should take no more than 38 percent of their monthly income to meet those obligations.

The guidelines are just guidelines and they are flexible. If you make a small down payment, the guidelines are more rigid. If you have marginal credit, the guidelines are more rigid. If you make a larger down payment or have sterling credit, the guidelines are less rigid. The guidelines also vary according to loan program. FHA guidelines state that a 29/41 qualifying ratio is acceptable. VA guidelines do not have a front ratio at all, but the back ratio is 41.

Because this calculation is an estimate, you should get pre-approved for a loan. This will tell you exactly how much you can afford and what your monthly payments will be. It will also allow you to determine how much cash you need for your down payment and closing costs. Being pre-approved by a lender can also increase your leverage during negotiations with the seller.