What Percentage Of Income Should Go To A Mortgage?

For most homeowners the most important financial commitment in their life is the mortgage on their home. But in financial terms a mortgage is not quite so heavy a concept.

It’s an agreement between you and a lender that allows you to borrow money to purchase or refinance a home and gives the lender the right to take your property if you fail to repay the money you've borrowed.

It’s in the best interest of both you and your lender that you can make your monthly mortgage payments with relative ease. Knowing what percentage of your income should go to your mortgage prevents you from buying more house than you can afford and potentially losing it.

So let’s dig in and find out where the sweet spot is – where the house you want to buy is the one you can also afford.  

How Much Of Your Income Should Go To Your Mortgage?

The best answer to this question is expressed as a percentage of your monthly gross income –the amount you reliably earn each month before taxes are taken out. If your income varies – perhaps it’s tied to tips or commissions – then estimate an average over 12 months.

Once you’ve determined this number, the 28% rule is a popular home buying guideline. The rule recommends buyers don’t spend more than 28% of their gross monthly income on their monthly mortgage payment.

28% Rule

The 28% rule is fairly easy to apply, but for this and some of the other calculations we’ll be making, the Rocket Homes^SM mortgage calculator is a convenient tool.

For this calculation it’s important that your “mortgage payment” includes all of the following: principal, interest, property taxes and homeowners insurance (also known as PITI).

You should also anticipate that while principal and interest are fairly easy to calculate, the amount you need to estimate for property tax and insurance will vary – sometimes significantly – depending on the locale of the real estate you’re buying. When you get to the point of looking at a particular home and community, your REALTOR^® should be able to give you a good idea of what these expenses will be.

For example, if your gross monthly income is $5,000, multiply that by .28 and arrive at a maximum monthly mortgage payment of $1,400.

The equation would look like this: 5,000 * .28 = 1400

25% Post-Tax Model

The 25% model works exactly like the 28% rule except that it likes to see your mortgage payment at or lower than 25% of your post-tax income. Because some borrowers may pay a significantly higher percentage of their income in taxes than others, some lenders believe that post-tax income is a more accurate figure on which to base their calculations.

35% / 45% Rule

While the concepts above take into account your debt burden in relation to either your pretax or post-tax income, the 35% / 45% rule looks at both. In this examination, allowing that different borrowers can have markedly different tax obligations, your total monthly debt, including your mortgage payment, shouldn't be more than 35% of your pretax income, or more than 45% of your after-tax income.

Factors That Influence Mortgage Affordability

As you’re applying for a mortgage, determining what percentage of your income should go to a mortgage is just one factor both you and your lender should and will consider. Additionally, current interest rates and housing market conditions, your employment and debt history, and your credit score all influence mortgage affordability – or how much you can borrow, at what interest rate, and upon which terms.

How Lenders Determine Your Mortgage Payment

There are several key metrics that all mortgage lenders will investigate to determine how much a borrower can afford, including:

●      Gross income: As we’ve seen, your income impacts your mortgage. A bank will only lend you money to buy a house up to a percentage of your gross income, typically viewed as your monthly income before taxes are withheld. They’ll ask to see recent pay slips, but also tax returns for the last year or two to see earnings over a wider time period.

●      DTI ratio: Based on your income as compared to your combined monthly financial obligations (bills, car payments, credit card payments, student loans, etc., and including a proposed mortgage from them), your lender will determine your debt-to-income ratio (DTI). 

●      Credit score: Your credit score tells lenders about your creditworthiness – how likely you are to pay back a loan based on your credit history. Most mortgage lenders require a score of at least 620 for a conventional loan. A higher credit score typically qualifies you for lower interest rates and better loan terms, and can save you thousands over time.

●      Employment history: Lenders not only want to know your current monthly income, they like to see that your income has been consistent over a longer period of time. Self-employment income should also reflect consistent earnings over time.

Tips On How To Lower Your Monthly Mortgage Payment

If you are eager to buy a house in a neighborhood that you really like but where home prices are going to be at or above what you can afford, there are some things you can do to lower your mortgage payment:

●      Improve your credit score: There are a number of ways you can build your credit score to lower your mortgage payment. Lenders often offer better interest rates and terms that will result in a lower monthly payment.

●      Make a bigger down payment: A larger down payment usually means smaller monthly mortgage payments. Since your loan balance is smaller, your monthly mortgage payments are smaller.

●      Get a longer mortgage term: There are advantages to getting a shorter-term mortgage, such as a 15-year versus a 30-year mortgage. In a 15-year mortgage you’ll pay down more of the principal each month and far less interest over the course of the loan. However, if you are really trying to keep your monthly payment down, a 30-year mortgage will have a lower mortgage payment.

The Bottom Line

Before you even begin the exciting process of buying a new home, you should have a clear idea of what percentage of your income will go to your mortgage. You and your lender can make a thorough assessment of your monthly earnings and debts and calculate how much house you can afford.

This process can be quick and easy when you apply online for a mortgage and see what kind of a loan you may qualify for.