If you’re a home buyer, how much home you can afford is one of the first questions you’ll need to answer. Calculating the percentage of income that should go toward your monthly mortgage payment is one of the biggest challenges first-time buyers face.
The percentage of income allocated to your monthly mortgage payment is your mortgage-to-income ratio. You can use several methods to determine the portion of income you should consider when calculating your mortgage-to-income ratio. Read on to learn how to determine how much of your income should go toward your mortgage.
Every homeowner’s situation is different. There’s no hard and fast rule about how much money you should spend on your mortgage each month. Still, experts have established rules to help borrowers avoid stretching their housing budget too thin.
The 28% Rule For Mortgage Payments
The often-referenced 28% rule says you shouldn’t spend more than 28% of your gross monthly income on your mortgage payment.
Gross income is the amount you earn before taxes, retirement account investments and other pretax deductions are taken out. The 28% threshold is often considered a safe mortgage-to-income ratio guideline for mortgage payments.
Use this formula to calculate the 28% rule:
Monthly mortgage payment = Gross monthly income ✕ 0.28
For example, if your gross monthly income is $5,000, you shouldn’t spend more than $1,400 on your monthly mortgage payment ($5,000 ✕ 0.28 = $1,400).
The 28% rule is popular with homeowners because it strikes a good balance between buying the home they want and having enough money in their budget for emergencies and other expenses.
However, you don’t need to spend up to your monthly maximum. Think of 28% as the cap on your monthly mortgage payment.
The 28/36 Rule For Mortgage Payments
You know about the 28% rule, but what is the 28/36 rule? The 28% portion of the rule is that you shouldn’t spend more than 28% of your monthly income on a mortgage payment.
The 36% portion of the rule is that you shouldn’t spend more than 36% of your gross monthly income on all your fixed monthly debt, like student loans, car loans or credit card payments, and your monthly mortgage payment.
Use this formula to calculate your maximum monthly mortgage payment using the 28/36 rule:
Monthly mortgage payment = Gross monthly income ✕ 0.28, or
Gross monthly income ✕ 0.36 – Fixed monthly expenses
If your gross monthly income is $5,000, you have $1,800 to spend on your mortgage and recurring debts ($5,000 ✕ 0.36 = $1,800). If your monthly mortgage payment is $1,400, that leaves you with $400 a month to pay your other debts. If your bills cost more than $400, you should consider a smaller monthly mortgage payment to avoid any difficulties covering your debts.
This is another good guideline to use if you’re trying to determine how much you can afford without stretching your budget.
The 35% / 45% Rule For Mortgage Payments
Some financial experts also recommend the 35%/45% model. With this rule, your total monthly debt, including your mortgage payment, shouldn’t exceed 35% of your pretax income or 45% after deductions. To calculate your maximum mortgage payment with this formula, use either formula:
Monthly mortgage payment = Gross monthly income ✕ 0.35, or
Monthly mortgage payment = Income after deductions ✕ 0.45
If your income is $5,000 before deductions, your maximum monthly mortgage payment would be $1,750 ($5,000 ✕ 0.35 = $1,750). If it’s $4,000 after deductions, your upper limit for your monthly payments would be $1,800 ($4,000 ✕ 0.45 = $1,800).
Let’s say you also pay for health insurance and child support, which lowers your net monthly income to $3,000. In this case, you may need to consider a lower monthly mortgage payment of $1,350 under the 35%/45% rule.
The 35%/45% rule may provide more latitude when calculating how much you can afford to spend each month on your mortgage, but it doesn’t factor in additional debts. However, the rule may be valuable when buying in an area with higher state and local income taxes. It may also be beneficial if you fall into a higher tax bracket or have a portion of income deducted for:
- 401(k) investments
- Health insurance or HSA account contributions
- Alimony or child support
The 25% Post-Tax Model For Mortgage Payments
The 25% post-tax model is more conservative. It says you should spend no more than 25% of your post-tax income on your monthly mortgage payment. For example, if you earn $4,000 after tax deductions, you’d spend a maximum of $1,000 a month on your mortgage ($4,000 ✕ 0.25 = $1,000).
The 25% model may be a better approach when dealing with other forms of debt, including student loans, auto loans, personal loans, etc. When you spend less on your monthly housing payment, you have more money to pay your bills.The model is also helpful if you want to save aggressively for the future. The model offers a lot of flexibility but provides less money to spend on a home.
What Is The Maximum Mortgage-To-Income Ratio Allowed?
Most conventional mortgage lenders allow a mortgage-to-income ratio of up to 45%, but it isn’t recommended. However, many home buyers may need to take advantage of these maximum ratios to live in an area with expensive homes or if they carry a lot of debt.
To determine the maximum percentage of income you can allocate toward your mortgage, use the following formula:
Monthly mortgage payment = Gross monthly income ✕ 0.45
With a $5,000 gross monthly income, your monthly mortgage payment can go as high as $2,250. But many lenders would prefer you don’t hit the ceiling on your monthly mortgage payment to allow some breathing room in your budget.
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How Will A Lender Calculate How Much I Can Afford?
In some of the examples above, you see how your monthly debt can affect affordability. Lenders also consider debt in addition to your gross income when estimating how much you can afford to borrow for a mortgage. Your debt-to-income ratio (DTI) also plays a major role in determining how much you can afford to borrow.
Your DTI ratio is a percentage that tells lenders how much of your monthly income goes toward debt. A higher DTI may make it difficult to qualify for a mortgage because it means you have less disposable income. Lenders must verify you aren’t taking on more debt than you can handle. If there’s no wiggle room in your budget, you may miss a mortgage payment if you experience financial hardship.
How To Get A Lower Monthly Mortgage Payment
To keep your mortgage-to-income ratio at a level you can afford, you may need to consider a lower monthly mortgage payment. Thankfully, you can use a few strategies to lower your monthly payment.
Step 1: Check Your Credit Report
One of the primary factors lenders consider when deciding how much you’ll pay in interest is your credit score. The higher your score, the lower interest rates you’ll qualify for. Before you can work on your credit score, you must get acopy of your credit report.
Carefully review your personal information and each entry to confirm everything is accurate. If you find discrepancies, you can dispute the inaccurate information with the credit bureau that has the error.
Review your payment history to ensure you don’t have any outstanding bills to pay. In many cases, paying off a delinquent account or correcting an error can make a noticeable difference in your credit score.
Step 2: Consider A Longer Mortgage Term
The longer your mortgage term, the lower your monthly payment. With a longer-term home loan, you spread your payments out over decades, which will lower your monthly mortgage payment. However, a longer-term loan will increase the total amount you pay in interest over the life of the loan.
Step 3: Save For A Larger Down Payment
If you can afford it, make a 20% down payment. Although you can qualify for a mortgage with a down payment that’s less than 20%, you’ll be required to pay private mortgage insurance (PMI), which gets added to your monthly mortgage payment. Avoiding PMI can reduce what you pay each month.
Step 4: Find The Best Interest Rate
When you’re finally ready to apply for a mortgage, compare the Loan Estimates you receive from lenders.
Getting prequalified and comparing your lender options is an extra step that’s worth the effort. Mortgage rates will vary depending on the lender and the type of loan you choose. Securing the lowest interest rate you qualify for can help you save on your monthly mortgage payment.
Mortgage-To-Income Ratio FAQs
Still have questions about how much of your income you should dedicate toward your mortgage payment? Get the answers you need to help you make a decision.
Why do lenders use my gross income to determine my mortgage payment?
Your gross monthly income is a reliable figure lenders can use to gauge your financial health. By comparing your gross income to your fixed monthly debt payments, a lender can quickly calculate how much money you have in your budget for a mortgage payment.
What does the term ‘house poor’ mean?
“House poor” describes homeowners who spend most of their income on their homes. A homeowner may be house poor due to an expensive monthly mortgage payment, expensive maintenance costs or high property taxes. To avoid this scenario, make sure your housing costs don’t overload your budget, leaving you with little left over for other expenses.
What other costs should I consider?
When estimating how much you can afford to spend on a mortgage, consider all expenses, even the ones you aren’t paying yet, which can include home repairs and improvements, maintenance costs and utility bills.
The Bottom Line
So, what percentage of your income should go toward your mortgage? The answer will vary depending on your income and debt. However, your income is only one of many factors that help determine how much home you can afford. Lenders look at everything from your credit score to your assets to decide how much you can borrow.
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Lauren Nowacki
Lauren is a Content Editor specializing in personal finance and the mortgage industry. Her writing focuses on reporting the best places to live in the U.S. based on certain interests and lifestyles. She has a Bachelor of Arts in communications from Alma College and has worked as a writer and editor for various publications in Philadelphia, Chicago and metro Detroit.
