It's essential to consider how much you can afford to pay before you look for a house. Considering affordability early on will save you time and money because you won't bid on unattainable houses or apply for loans that are out of your ballpark. It will be easier to get a loan, and, if necessary, you will be able to take creative steps toward improving your financial and credit profile.

How Much House Can You Afford?

As a broad generalization, most people can afford to purchase a house worth about three times their total (gross) annual income, assuming a 20% down payment and a moderate amount of other long-term debts, such as car or student loan payments. With no other debts, you can probably afford a house worth up to four or even five times your annual income.

Lenders normally want you to make all monthly housing payments with 28%-38% of your monthly income -- the percentage depends on the amount of your down payment, the interest rate on the type of mortgage you want, your credit history, the level of your long-term debts and other factors. Generally, the greater your other debts, the lower the percentage of your income lenders will assume you have available to spend each month on housing. Conversely, if you have no long-term debts and a great credit history and will make a larger than normal down payment, a lender may approve carrying costs that exceed 38% of your monthly income.

Check Your Credit History

When reviewing loan applications and making financing decisions, lenders typically request that the credit bureaus reporting your file
-- Equifax, Experian, or TransUnion -- provide your credit risk score, a statistical summary of the information in your credit report, including:

• your history of paying bills on time
• the level of your outstanding debts
• how long you've had credit
• your credit limit
• the number of inquiries for your credit report (too many can lower your score), and
• the types of credit you have.

The higher your credit score, the easier it will be to get a loan. If you routinely pay your bills late, you can expect a lower score, in which case a lender may either reject your loan application altogether or insist on a very large down payment or high interest rate to lower the lender's risk.

Because your credit history has such an important effect on the type and amount of mortgage loan lenders offer you, always check your credit report and clean up your file if necessary -- before, not after, you apply for a mortgage.

Loan Preapproval vs. Loan Prequalification

Once you've done the basic calculations and completed a financial statement, you can ask a lender or loan broker for a prequalification letter saying that loan approval for a specified amount is likely based on your income and credit history. Prequalifying lets you determine exactly how much you'll be able to borrow and how much you'll need for a down payment and closing costs. Many of the mortgage websites have prequalifying calculators to help with this task.

Unless you're in a very slow market, with lots more sellers than buyers, you will want to do more than prequalify for a loan -- you will want to be preapproved -- that is, guaranteed for a specific loan amount. This means a lender has already checked your credit and evaluated your financial situation -- rather than simply relying on your own statement about your income and debts. Preapproval means that the lender would actually fund the loan, pending an appraisal of the property, title report and purchase contract. Having a lender preapprove you for a loan is crucial in a competitive market; without it you stand little chance of your offer being accepted.