Shopping for a new home? Before making an offer, you’ll want to know how much you can afford to spend. Yet figuring out the percentage of income that should go toward a mortgage payment is among the biggest challenges first-time buyers face.
When assessing home affordability, buyers should consider their front-end debt-to-income (DTI) ratio, also known as the housing ratio. Expressed as a percentage, this figure shows what portion of your gross income accounts for housing expenses. (For this calculation, these expenses include principal interest, homeowners insurance and property tax payments.) Of course, every homeowner’s situation differs, but you never want to overextend your household budget or be unable to pay your mortgage.
DTI ratios are useful for prospective home buyers, but they’re also a key metric lenders use to determine if you can afford a home loan. So it’s important to understand how they work. Luckily, there are some basic percentage guidelines for mortgage payments that can help you figure out how much house your paycheck can afford.
Key Takeaways:
- Your loan type, interest rate and especially loan term will impact your monthly payment amount – and therefore what loan size fits your budget.
- When calculating your expenditures, consider your income streams, debt load, credit score, daily expenses and savings.
- Saving for a larger down payment is one way to help reduce your monthly payments on a mortgage.
The 28% Rule For Mortgage Payments
One approach to determining how much of your income you can comfortably afford to devote to a mortgage payment is the 28% rule. Simply put, this means limiting your monthly mortgage payment to no more than 28% of your gross monthly income. This percentage is generally considered a financially safe mortgage-to-income ratio for buyers.
How To Calculate The 28% Rule
Gross monthly income × 0.28 = Recommended maximum monthly mortgage payment
Here’s an example of how it works in practice: Let’s say you earn $5,000 per month in gross income. If you applied the 28% rule, you’d cap your mortgage payment at $1,400 per month. The rest of your income would then be available for other financial obligations, such as car payments, student loans, household expenses and savings.
While 28% may feel financially conservative, the rule can help you avoid becoming “house poor” by leaving ample room in your budget for those other expenses. You can also apply the rule with some flexibility – you don’t need to spend up to the maximum, of course. And on the other hand, when home prices rise, it may be difficult to stick to this percentage. It may help to think of 28% as a guideline, rather than a strict hard target, to keep you from borrowing more than you can afford.
The 28/36 Rule For Mortgage Payments
The 28/36 rule is another guideline that can assist you in deciding how much mortgage you can afford. It states that housing costs should not exceed 28% of an individual’s gross monthly income, and that the individual’s total debts (housing costs plus car loans, student loans, credit cards, etc.) should not exceed 36% of their gross monthly income.
How To Calculate The 28/36 Rule
Gross monthly income × 0.28 = Recommended maximum monthly mortgage payment
Gross monthly income × 0.36 = Recommended maximum of all monthly debt payments
Here’s how this one works in action: Let’s say your gross monthly income is $5,000 again. Under the 28/36 rule, you could spend up to $1,400 per month on housing costs (28% of your income, as noted above). In addition, your total monthly debt payments – including mortgage, credit cards, student loans, and car loans – should not exceed $1,800 (36%). That leaves you with plenty left over for everyday expenses, savings and unexpected financial needs.
This rule may also feel conservative, but keeping all your debt-related expenses – including housing – at 36% of your income or below can help you maintain financial comfort and reduce your risk of falling behind on your mortgage.
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The 35/45 Rule For Mortgage Payments
Some financial experts recommend instead using the 35/45 model to figure out how much you can comfortably spend on a mortgage. Under this approach, your total monthly debt payments, including your mortgage, shouldn’t exceed 35% of your gross income, or 45% of your monthly net income (your monthly income after taxes and other deductions are taken out).
How To Calculate The 35/45 Rule
Gross monthly income x 0.35 = Recommended maximum of all monthly debt payments
or
Net monthly income x 0.45 = Recommended maximum of all monthly debt payments
Going back to our example, let’s say you earn $5,000 a month before taxes and net $4,000 as take-home pay. Using this strategy, you can afford to spend $1,750 (35%) of your gross income of $5,000 on a mortgage payment. In this case, that payment would also keep you under the recommended 45% threshold in relation to your net income (the $1,750 payment accounts for around 44%).
The 35/45 strategy lets you set a budgetary range for how much you can spend on your mortgage. With the above income, your mortgage payment would range from $1,750 (based on the 35% calculation) to $1,800 (based on 45%). Spending $1,750 a month would fit both recommendations, which may be an ideal scenario.
This method also enables you to assess your housing costs relative to your take-home pay (net income), while still allowing you to understand their impact on your financial big picture (gross income). But remember to take into account your non-housing-related expenses, to ensure you don’t overallocate for your mortgage. Spending the whole 45% of your take-home pay on housing expenses may be fine if your other expenses and debts are minimal, but it might not be a practical strategy if you already have a large debt load to manage.
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The 25% Post-Tax Model For Mortgage Payments
The most conservative angle on how much mortgage you can afford is the 25% post-tax model. You simply aim to spend no more than 25% of your take-home pay (net income) on your monthly mortgage payment.
How To Calculate The 25% Post-Tax Model
Net monthly income x 0.25 = Recommended maximum monthly mortgage payment
Returning one last time to our example, where you earn $4,000 a month after taxes, if you followed this strategy, your mortgage payment would ideally be no more than $1,000. While this may seem like very little, the approach can be useful if you already have other significant debts, such as student loans and car payments, or high-interest debt, like credit cards or personal loans.
The 25% Post-Tax model does limit your spending on a home even more than the others, but it also gives you the most financial breathing room. Overall, it can be a safe and flexible rule to follow to ensure your mortgage payment doesn’t put other important expenses or savings goals at risk.
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How Does A Lender Calculate How Much I Can Afford?
There’s yet another ratio lenders use when evaluating loan applications: your back-end debt-to-income (DTI) ratio. While your front-end DTI ratio includes only your monthly housing expenses to calculate the percentage, this version adds in all your debt payments – including car payments, student loans, credit cards, and the like.
Fannie Mae – a government-backed company that helps set U.S. mortgage loan standards – stipulates a maximum back-end DTI ratio of 36% for conventional loans. However, this maximum may be extended to 45% (based on the individual’s credit and finances).
When considering how much you can afford to spend on a home, understand that lenders – who need to verify that you aren’t taking on more debt than you can handle – always look at this big-picture snapshot. While you may feel that spending 35% of your gross income is comfortable, they may feel otherwise if your total debt load pushes your back-end DTI ratio beyond 36%.
How To Get A Lower Monthly Mortgage Payment
There are a few strategies you can use to qualify for better terms and a lower monthly mortgage payment – and thereby achieve lower DTI ratios.
Check Your Credit Report
One of the primary factors lenders consider when deciding how much interest to charge is your credit score. Most conventional lenders want to see a credit score of at least 620. If you are taking out an FHA loan, you generally need to have a credit score between 500 – 580. In all cases, you’ll need a higher score to qualify for the best rates and terms on a mortgage.
Getting a formal copy of your credit report is one of the best ways to understand your credit journey. You can now obtain a free copy of your credit report from all three major credit bureaus (TransUnion®, Experian® and Equifax®) each week by using AnnualCreditReport.com.
Carefully review your report to confirm everything is accurate. If you find discrepancies, you can dispute the inaccurate information with the credit bureau that has the error. Also check your payment history for any outstanding bills, and if you have a delinquent account, make a payment to bring it current.
Correcting errors and keeping all your accounts in good standing can make a noticeable difference in your credit score over time.
Examine The Trade-Offs Of A Longer Mortgage Term
Another way you may be able to achieve lower monthly payments is by taking out a longer mortgage term – say a 30-year mortgage rather than a 15-year one. But there are trade-offs.
A longer mortgage term means you’ll be building equity in your home at a slower pace, and it will of course take you longer to own your home outright. It also means paying more – often a lot more – in interest over the life of the loan, both inherently because of the longer period you’re paying interest, and because lenders tend to offer higher interest rates for longer-term loans.. Still, in some cases, a longer mortgage term may make sense, such as if you strongly prefer a lower monthly payment or need more financial flexibility in your budget.
Either way, understanding the impact of a mortgage term on home affordability is crucial. The table below shows how the cost of borrowing changes for a $400,000 home (assuming a 20% down payment and a 6.5% interest rate without escrowing property taxes or insurance) when shifted among 15-year, 20-year and 30-year mortgage terms:
| Term | Monthly Payment | Total Interest Paid |
|---|---|---|
| 15 years | $2,787.54 | $181,757.84 |
| 20 years | $2,385.83 | $252,600.17 |
| 30 years | $2,022.62 | $408,142.36 |
Save For A Larger Down Payment
If you can afford it, consider putting down at least 20% when making an offer on a home. You can qualify for a mortgage with a smaller down payment, but if you offer less than 20%, you’ll be required to pay private mortgage insurance (PMI). Since the PMI cost will be added to your monthly mortgage payment, avoiding it will reduce that amount.
Find The Best Interest Rate
After you apply for a mortgage, you’ll receive a loan estimate document (sometimes referred to as a good faith estimate) from your lender. Mortgage rates will vary depending on the lender and the type of loan you choose. Securing the lowest interest rate you can qualify for will help you save on your monthly mortgage payment.
FAQ
The Bottom Line: How Much Mortgage You Can Afford
There isn’t a single rule to help you answer the question of how much of your income should go to your mortgage payment. And while affordability formulas and income-to-mortgage ratios are helpful tools and starting points, the amount you can afford will also depend on other factors, like the cost of living in your area, the kind of home you want to purchase and your lifestyle.
For example, in high-cost locations, you may need to adjust your dream home expectations or plan for a slightly higher DTI ratio to afford a home. Or if you have upcoming life changes that involve additional expenses, like the arrival of a new family member, you may want to spend less on your mortgage to make sure you have some financial padding in your budget.
But whatever your situation, if you’re concerned about qualifying for the mortgage loan you need, improving your DTI ratio may give you stronger borrowing power, and a strong credit score may give you a lower interest rate on your loan.
Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
