Buying a home is an exciting milestone. But before you start house hunting, it's important to know if you can actually afford the monthly mortgage payments. When applying for a home loan, lenders want to see that your income is sufficient to make the payments comfortably each month.
So how much income do you really need to qualify for a $400,000 mortgage? While there are general guidelines, the exact amount can vary based on your specific financial situation. In this comprehensive guide, we’ll break down the key factors that determine mortgage eligibility, so you can find the home of your dreams without breaking the bank.
What is the Minimum Income Threshold for a $400K Home Loan?
As a general rule of thumb, most mortgage lenders want to see that your gross annual income is at least three times the loan amount. So for a $400,000 home loan, you would need an annual income of around $120,000 to comfortably afford the monthly payments.
Of course, this can fluctuate depending on where you live. In high cost-of-living areas like New York or San Francisco, lenders may require higher incomes to account for the increased housing prices. In lower cost areas of the country, you may be able to qualify for a $400K mortgage with an income closer to $100,000.
The best way to determine the income needed for your situation is to speak with a loan officer. They can assess your specific finances and provide a more accurate estimate based on your location, credit score, existing debts, and down payment amount.
How Does the Down Payment Percentage Affect Income Requirements?
Putting down a larger down payment on a home can definitely help reduce the amount of income you need to qualify. That’s because a higher down payment lowers the principal loan amount you have to borrow.
For example, if you put down a 10% down payment on a $400,000 home, you would need to finance $360,000. But with a 20% down payment, that loan amount drops to $320,000. Since your monthly mortgage payments are based on the amount borrowed, having a lower principal can significantly decrease the income needed.
Most conventional loans require at least a 20% down payment to avoid having to pay private mortgage insurance (PMI). But programs like FHA loans allow down payments as low as 3.5%. Just keep in mind that lower down payments lead to higher monthly costs.
How Do Lenders Calculate the Required Income for a Mortgage?
When reviewing a mortgage application, lenders want to confirm that your total monthly debt payments aren’t exceeding a certain percentage of your gross monthly income. The two key ratios used are:
Front-end DTI: Also called the housing ratio, this looks at your proposed mortgage payment as a percentage of your monthly income. Most lenders limit this to 28%.
Back-end DTI: Also known as the debt-to-income ratio, this looks at your total monthly debts divided by your gross monthly income. The back-end DTI is capped at 36% for most conventional loans.
So for that $400,000 mortgage example, let’s assume you need to borrow $360,000 with a 10% down payment. At a 30-year fixed rate of 5%, your estimated monthly mortgage payment would be around $1,900.
If your gross monthly income is $10,000, then your front-end DTI is 19% ($1,900 / $10,000), well below the 28% limit. And as long as your total monthly debts don’t exceed $3,600 (36% of $10,000), you should comfortably fall within the back-end DTI as well.
Why is Your Credit Score Important for Mortgage Approval?
Your credit score gives lenders an indication of how reliably you’ve managed debts and payments in the past. So not surprisingly, it can significantly impact your mortgage eligibility and interest rate.
Most conventional loans require a minimum credit score in the fair to good range—around 620 to 640. But for the best mortgage rates, you’ll want a score of at least 740. Here are the ranges for common credit tiers:
- Poor: Below 580
- Fair: 580–669
- Good: 670–739
- Very Good: 740–799
- Exceptional: 800 and above
The higher your credit score, the more likely you are to be approved for a lower interest rate. For example, on a $400,000 30-year fixed mortgage, the interest rate difference between a 620 credit score and a 740 score can be 0.5% or more. Over the life of the loan, that can amount to tens of thousands of dollars in extra interest paid.
Checking your credit report ahead of time gives you a chance to correct any errors that may be dragging down your score. Taking steps to pay down balances and dispute mistakes can bump up your credit numbers and improve your mortgage eligibility.
What Other Factors Determine if You’ll Qualify for a Home Loan?
Beyond just income and credit score, lenders dig deep into your full financial profile to assess mortgage eligibility. Here are some other key aspects they’ll evaluate:
- Job history and stability: Length of time employed in the same field or company.
- Existing debts: Lower DTI ratios are better, so work to minimize credit card balances.
- Down payment source: Lenders want to document where the funds are coming from, like your savings account.
- Assets and reserves: Many lenders require reserves equal to 6-12 months of mortgage payments.
- Property type: Single-family homes are preferable to condos or investment properties.
Bringing supporting documents for income, assets, debts, and credit scores can help streamline the verification process. Being able to cover closing costs and meet reserve requirements also makes for a smoother approval.
Should I Choose a Fixed or Adjustable-Rate Mortgage?
One of the biggest decisions is whether to opt for a fixed or adjustable-rate mortgage. Here’s a quick rundown of how they compare:
Fixed-Rate Mortgage
- Interest rate stays the same for the full loan term (often 15 or 30 years).
- Monthly principal and interest payments are predictable.
- Makes budgeting easier.
- No risk of rate spikes.
- Typically has higher rate than adjustable mortgages.
Adjustable-Rate Mortgage (ARM)
- Initial fixed period (5, 7 or 10 years) before rate starts adjusting annually.
- Rate tied to an index like prime rate, so payments can fluctuate.
- Lower initial interest rate than fixed mortgages.
- Payment shock risk when rate resets higher.
- Caps limit rate changes each period.
Fixed-rate mortgages provide stability, while ARMs offer lower initial costs but uncertainty long-term. Your choice often depends on your timeline—how long you plan to stay in the home. Speak with your lender to weigh the pros and cons for your individual situation.
Are Conventional or FHA Loans Better for First-Time Homebuyers?
For purchasing a primary residence, most buyers choose between a conventional or FHA loan. Here are some key differences:
Conventional Loan
- Typically requires a 20% down payment.
- Allows higher DTI ratio, up to 50% in some cases.
- Minimum 620 credit score.
- No monthly mortgage insurance if 20% down.
- Lower interest rates than FHA.
FHA Loan
- Only 3.5% down payment required.
- Accepts credit scores as low as 580.
- Higher DTI ratio allowed.
- Mortgage insurance is required and permanent.
- Slightly higher interest rate than conventional.
Conventional loans offer better rates but aren’t always realistic for first-time buyers due to the large down payment. FHA loans provide more lenient qualifying terms but cost a bit more overall. Shopping and comparing quotes from both types of lenders can help find the best fit.
How Do Shorter or Longer Loan Terms Impact Your Mortgage Payments?
Most mortgages are structured for either 15 or 30 years. The loan term dramatically impacts your monthly payment, so it’s an important factor to consider.
On a $400,000 loan amount, here’s how the monthly principal and interest payments differ:
- 15-year term: $2,905 per month
- 30-year term: $1,997 per month
While the shorter 15-year term comes with a higher payment, you’ll pay far less interest over the life of the loan. You’d save over $186,000 in total interest costs for the same $400,000 loan by going with a 15-year mortgage.
The longer 30-year term is more affordable monthly but you end up paying nearly twice as much interest. Calculate the payments for both options and determine what you can reasonably handle each month.