How Much Of Your Income Should Go To Your Mortgage?

When you’re buying a home, it’s important to consider the breakdown of your monthly expenses alongside the overall cost. One of the largest and most significant expenses you’ll pay each month after purchasing a home is a mortgage.

Before you commit to your forever home or next investment property, you’ll likely find it helpful to know how much of your income you can expect to allocate to that monthly mortgage payment.

In this article, we’ll take a look at some of the general rules and formulas you can follow to calculate your mortgage-to-income ratio and determine how much home you can afford.

To determine how much income should be put toward a monthly mortgage payment, there are several rules and formulas you can use. The most popular is the 28% rule, which states that no more than 28% of your gross monthly income should be spent on housing costs.

Although most personal finance experts recommend the 28% rule, there are several other rules and guidelines that can be helpful in your calculations. Let’s take a look at a few.

The 28% / 36% Rule

The 28% / 36% rule is based on two calculations: a front-end and back-end ratio. As we’ve discussed, this rule states that no more than 28% of the borrower’s gross monthly income should be spent on housing costs – but it also states that no more than 36% should be spent on total debt costs.

To use this calculation to figure out how much you can afford to spend, multiply your gross monthly income by 0.28. For example, if your gross monthly income is $8,000, you should spend no more than $2,240 on a monthly mortgage payment.

The 35% / 45% Rule

The 35% / 45% rule emphasizes that the borrower’s total monthly debt shouldn’t exceed more than 35% of their pretax income and also shouldn’t exceed more than 45% of their post-tax income.

To use the first part of this rule, you’ll need to determine your gross monthly income before taxes and multiply it by 0.35. For the second part, multiply your monthly income after taxes by 0.45.

The 25% Rule

The 25% rule allows borrowers to use their net income in calculations, which may be easier for borrowers who are unsure about their gross monthly income. This rule states that no more than 25% of your post-tax income should go toward housing costs.

To follow this model, multiply your monthly income after taxes by 0.25.

When mortgage lenders review your finances, they use the following ratios to determine how much you can afford to borrow.

• Front-end ratio: Also called the mortgage-to-income ratio, this represents the percentage of your monthly gross income that goes toward mortgage costs. This number is calculated by dividing the expected monthly mortgage payment by the borrower’s gross monthly income.
• Back-end ratio: Commonly referred to as the debt-to-income ratio (DTI), which is the percentage of your gross monthly income spent on debt payments including student loans, auto loans, personal loans and so on. This number is calculated by dividing total debt costs per month by the borrower’s gross monthly income.

Additional Mortgage Requirements

It’s important to remember that your income is just one piece of the puzzle when it comes to qualifying for a mortgage.

In addition to income – which refers to all of your wages and other earnings before taxes – lenders look at several factors when determining whether a borrower will qualify for home financing, including the following:

• Credit score: Your credit score helps the lender analyze the risk associated with lending you the money to buy a house. Precise credit score requirements depend on the loan type and lender, but in general, you’ll need a score of at least 620 for a conventional loan.
• Debt: Your debt-to-income ratio shows how much you earn compared to how much a mortgage would cost. Lenders use this to see how easily you would be able to afford a monthly mortgage payment.
• Down payment: Though not everyone can afford to put 20% down, a larger down payment will mean a lower monthly mortgage payment.

To understand how much of your income should go to a mortgage, it’s helpful to understand the components that make up a mortgage payment. Each month, a portion of your payment will go toward PITI – principal, interest, property taxes and homeowners insurance.

Also, if you make a down payment of less than 20%, you’ll have the added fee of mortgage insurance tacked onto your payment each month. This type of insurance protects lenders’ investment in the event that you default on the loan. For a conventional loan, this is usually paid in the form of private mortgage insurance (PMI).

While running the percentage of income calculations, you may realize that you can’t afford the monthly payment on your ideal home – but don’t fret! While you may not be able to directly control your income, there are other strategies you can use to lower your monthly mortgage payments.

• Improve your credit score: Higher credit scores mean better loan terms, including a lower interest rate, so taking action to improve your score is always a good idea before applying for a mortgage.
• Make a larger down payment: As we’ve mentioned, larger down payments often mean lower monthly payments, so consider taking the extra time to save for this upfront cost. As a bonus, a higher down payment (at least 20%) will also allow you to avoid paying for mortgage insurance.
• Change your loan term: You can also lengthen your loan term. By making the loan term longer, you’re spreading your principal balance across a longer period, making monthly payments cheaper, at the cost of paying more in interest over the lifetime of the loan.

If you still have some questions about the mortgage-to-income ratio and other mortgage-related topics, read the answers to some frequently asked questions.

What expenses do I need to prepare for besides my mortgage?

When you’re buying a home, you’ll need to prepare for a few upfront expenses, such as your down payment and closing costs, as well as monthly or recurring expenses, including your mortgage, HOA fees, home maintenance and more. It’s important to factor these items into your budget so you truly understand how much house you can afford.

What mortgage loan options are available?

When you buy a home, there are several mortgage loan options to choose from, including conventional mortgages, fixed-rate mortgages, adjustable-rate mortgages and government-backed loans including FHA loans, USDA loans and VA loans. You’ll want to research and learn more about each type of loan to figure out which one best suits your needs.

How much debt can I have and still get a mortgage?

Most mortgage lenders will want your monthly debt to be less than or equal to 43% of your gross monthly income. However, it’s possible you could be approved with up to 50% or higher.

How does a down payment affect my monthly mortgage payment?

Down payment requirements vary by loan type, but typically the larger a down payment you make, the smaller your monthly mortgage payment will be. You can also avoid the added expense of mortgage insurance if you make a down payment of at least 20%.

When you’re preparing to buy a home, it’s important to consider the overall cost alongside the monthly costs to ensure you’re not biting off more than you can chew financially. Using a percentage of income rule and calculation, you can feel more confident in precisely how much home you can afford to buy.

If you’re ready to take the next step toward homeownership, apply for a mortgage and get started.