Buying a home is a major financial decision, and one of the key questions homeowners ask is: how much of your income should go to a mortgage? Historically, financial experts recommend spending no more than 30% of your monthly income on housing costs. However, with rising home prices and mortgage rates, this rule has become increasingly difficult to follow.
In this blog, we’ll break down how to determine a comfortable mortgage budget, the factors lenders consider when assessing affordability, and strategies to help you manage your monthly mortgage payments.
What’s Included in a Mortgage Payment?
To better understand how much you can afford, let’s look at what makes up a mortgage payment. Lenders refer to it as PITI:
- Principal: The amount you borrowed for the home purchase.
- Interest: The cost of borrowing the principal, based on your mortgage rate.
- Taxes: Property taxes set by your local government.
- Insurance: Homeowners insurance to protect against damages.
If you make a down payment of less than 20%, you’ll likely also pay mortgage insurance, which protects lenders in case of default. Taxes and insurance can often be included in monthly mortgage payments via an escrow account managed by your lender.
How Much of Your Income Should Go to a Mortgage?
While the general rule of thumb is 30% of your gross income, experts now recognize that a range of 25-35% is more realistic, depending on personal circumstances. Here are a few common methods to calculate affordability:
1. Debt-to-Income (DTI) Ratio
Lenders use the DTI ratio to determine how much of your income is spent on debts, including your mortgage payment. Ideally:
- Your total debts (including mortgage) should be less than 50% of your gross income.
DTI Example:
If your gross monthly income is $10,000, and you spend $3,600 on a mortgage, plus $550 on other debts (car loans, credit cards):
2. The 28%/36% Rule
This rule suggests:
- Spend no more than 28% of your gross income on housing costs.
- Keep total monthly debts below 36% of your gross income.
Example:
For a $10,000 monthly income:
- $10,000 x 0.28 = $2,800 for mortgage costs.
- $10,000 x 0.36 = $3,600 for total debts.
3. The 35%/45% Rule
This rule adjusts for today’s higher costs:
- Housing and debts should not exceed 35% of your gross income or 45% of your post-tax income.
Example:
Gross income: $10,000 | Net income: $9,000
- $10,000 x 0.35 = $3,500 (pre-tax limit).
- $9,000 x 0.45 = $4,050 (post-tax limit).
4. 25% Post-Tax Rule
For a more conservative approach, aim to spend 25% of your after-tax income on housing.
Example:
If your net income is $7,500:
- $7,500 x 0.25 = $1,875 for your mortgage.
What Lenders Look At When Determining Affordability
To decide how much you can borrow, lenders assess:
- Gross Income: Combined income of all borrowers.
- Debt-to-Income Ratio: Keeping DTI below 50% improves your loan terms.
- Credit Score: Higher scores qualify for lower interest rates.
- Employment History: Consistent income and at least two years of steady employment.
Tips to Lower Your Monthly Mortgage Payments
Buying a home doesn’t mean stretching your budget to the limit. Here are strategies to make homeownership more affordable:
- Make a Larger Down Payment: A down payment of at least 20% eliminates mortgage insurance and reduces your loan amount.
- Choose a Longer Loan Term: A 30-year mortgage lowers monthly payments compared to a 15-year loan.
- Improve Your Credit Score: Better credit scores unlock lower interest rates.
- Consider Co-Buying: Buying with a partner, friend, or relative can increase affordability.
- Move to a Less Competitive Market: Relocating to an area with a lower cost of living can save thousands.
Managing an Existing Mortgage: Lower Your Payments
If you already own a home, here’s how you can reduce your mortgage burden:
- Bi-Weekly Payments: Make half-payments every two weeks to pay off your loan faster.
- Refinancing: Replace your mortgage with a new one to secure better terms.
- Rent Out a Room: House hacking—renting part of your home—can help offset costs.
Final Thoughts
Determining how much of your income should go to a mortgage requires balancing affordability with your homeownership goals. Stick to a budget that aligns with your financial comfort, and remember: just because you’re approved for a certain loan amount doesn’t mean you should spend it all.
By carefully assessing your income, debts, and long-term goals, you can confidently find a mortgage payment that fits your lifestyle without compromising your financial health.
Ready to take the next step? Start by calculating your mortgage budget and getting pre-qualified to see how much home you can afford!
