What percentage of your income should go to mortgage
Your income is a major factor in how much house you can afford. But what percentage of your income should go to your mortgage? Is there a “golden rule” or consensus about how much you should spend on a mortgage? While the final answer is different for everyone, there are a few general guidelines and tips on what percentage of your income should go to a mortgage.
What is a mortgage payment?
A mortgage payment is the amount you pay your lender each month for your home loan, which includes principal and interest. Sometimes, these payments also include property or real estate taxes, increasing the amount you pay. Mortgage payments are typically made monthly, but there may be other schedules available, such as bi-weekly or semi-monthly payments.
Mortgage to income ratio: Common rules
To determine how much you should spend on a mortgage every month, it’s generally recommended to start by understanding your income, financial goals and current debts. Here are a few general rules of thumb that might help you get started. These examples can help you identify how much you can afford:
The 28% rule
The 28% mortgage rule states that you should spend 28% or less of your monthly gross income on your mortgage payment (including principal, interest, taxes and insurance). To gauge how much you can afford using this rule, multiply your monthly gross income by 28%. For example, if you make $10,000 every month, multiply $10,000 by 0.28 to get $2,800. Using these figures, your monthly mortgage payment should be no more than $2,800.
The 28/36 rule
The 28/36 rule expands on the 28% rule by also considering your total debt-to-income ratio. It suggests limiting your mortgage costs to 28% of your gross monthly income and keeping your total debt payments, including your mortgage, car loans, student loans, credit card debt and any other debts, below 36%. The goal of the 28/36 rule is to consider your overall financial situation and help prevent overextending yourself with new debt obligations.
The 35/45 rule
With the 35/45 model, your total monthly debt, including your mortgage payment, shouldn't exceed 35% of your pre-tax income or 45% of your after-tax income. To estimate your affordable range, multiply your gross income before taxes by 0.35 and your net income after taxes by 0.45. The amount you can afford falls between these two figures. For example, let's say your monthly income is $10,000 before taxes and $8,000 after taxes. Multiply 10,000 by 0.35 to get $3,500. Then, multiply 8,000 by 0.45 to get $3,600. According to the 35/45 model, you could potentially afford between $3,500 and $3,600 per month. The 35/45 mortgage rule of thumb generally offers you more money to spend on your monthly mortgage payments than other models.
The 25% post-tax rule
The 25% post-tax model suggests keeping your total monthly debt at or below 25% of your post-tax income. To calculate your affordable mortgage payment, multiply your post-tax monthly income by 0.25. For example, if you earn $8,000 after taxes, you may be able to afford up to $2,000 for your monthly mortgage payment. This is generally considered a more conservative mortgage to income ratio than some other models.
While these mortgage rules of thumbs can be a helpful starting point for determining a percentage of income for your mortgage, it’s generally wise to consider your personal financial situation and goals. A qualified home lending advisor can provide more tailored guidance as to which mortgage options might be suitable for you and your financial needs.
How do lenders determine what I can afford?
Mortgage lenders assess your mortgage qualifications based on several factors, including your income, debt-to-income (DTI) ratio and credit score. Let’s take a closer look at each of these factors:
Gross income
Gross income is the total amount of money you earn before taxes and other deductions. Lenders consider your gross income, not your net income, when evaluating your ability to make monthly mortgage payments. A higher gross income generally indicates you can afford a more expensive home.
Debt-to-Income (DTI) ratio
Your DTI ratio compares your monthly debt payments to your gross monthly income. To calculate your DTI ratio, divide your total monthly debt (Including mortgage payments, car loans, student loans and credit card balances) by your gross monthly income, then multiply by 100. A lower DTI ratio generally suggests you have more disposable income available to make mortgage payments, potentially improving your mortgage application.
Credit score
Your credit score represents your creditworthiness, based on factors including your payment history, credit utilization and length of your credit history. A higher credit score generally indicates lower risk to lenders, which can improve your chances of qualifying for a mortgage and securing more favorable terms. Note that minimum credit score requirements can vary, so it’s best to speak with your lender for more information.
Tips for lowering your monthly mortgage payments
For most people, securing a lower mortgage payment is often a top concern. Here's some helpful advice on how to do that:
Increase your credit score
To increase your credit score, it’s generally recommended to pay your bills on time, pay down existing debt and avoid opening new credit accounts unless necessary. Remember that closing unused credit accounts may negatively impact your credit score by increasing your credit utilization ratio.
Extend your loan term
Choosing a longer loan term, such as a 30-year mortgage instead of a 15-year mortgage, can lower your monthly payments by spreading the cost of your loan over a longer period. Keep in mind, however, that this will generally mean paying more interest over the life of the loan.
Make a larger down payment
Making a down payment of at least 20% can help you avoid private mortgage insurance (PMI), which is typically required for borrowers with lower down payments. Eliminating PMI can help reduce your monthly mortgage expenses. Additionally, a larger down payment means you’ll need to borrow less money — which may further reduce your monthly payments.
Request a home tax reassessment
If you already own a home or it's in escrow, consider filing for a reassessment with your county and requesting a hearing with the State Board of Equalization. Each county performs a tax assessment to determine how much your home or land is worth. A reassessment may lower your property taxes, potentially lowering your monthly mortgage payment too. Keep in mind that a reassessment could also result in a higher property valuation, increasing your property taxes. It’s generally recommended to research ahead of time and consult a qualified tax professional before seeking a reassessment.
Refinance your mortgage
If interest rates have dropped since you obtained your original mortgage, it may be worth considering a mortgage refinanceec-refinance-hl000061ec-refinance-hl000061. While refinancing to a lower rate can lower your monthly payments, it might be wise to consider the costs associated with refinancing and whether the long-term savings outweigh these expenses. Like applying for a new mortgage, it’s recommended to improve your credit score before seeking a mortgage refinance.
In summary
So, what percentage of income should go to mortgage? Ultimately, it’s different for everyone and your ideal mortgage-income ratio will be dependent on the specifics of your financial situation. There are, however, a few mortgage rules of thumb you could consider to help you get started. It’s also helpful to speak with a home lending advisor or use an online mortgage calculator to help you determine what percentage of your salary should go towards a mortgage loan.
Mortgage-to-income ratio FAQs
1. Do mortgage lenders use gross or net income?
Mortgage lenders typically use your gross income when determining how much you can afford to borrow. Gross income is your total earnings before any taxes or deductions. Lenders use this figure to evaluate key financial metrics, such as your debt-to-income ratio, to assess your ability to repay the loan.
2. Does mortgage interest reduce taxable income?
Yes, mortgage interest can potentially be used to reduce taxable income. Homeowners who itemize their deductions on their federal tax return may be able to deduct the interest paid on a mortgage. This deduction may apply to mortgages on a primary residence and, in some cases, a second home. However, there are limits and eligibility criteria, so it’s generally recommended to consult with a tax professional for specific guidance.
3. Does the length of the home loan term impact the mortgage-to-income ratio?
Yes, the length of the home loan term does impact the mortgage-to-income ratio. Longer loan terms, like a 30-year mortgage, typically have lower monthly payments, which can result in a lower mortgage-to-income ratio. Conversely, shorter loan terms, like a 15-year mortgage, often have higher monthly payments, leading to a higher mortgage-to-income ratio.
4. What other factors should I consider when determining how much my mortgage should be?
To help determine an appropriate amount for your routine mortgage payments, you’ll generally want to consider factors like your current debts, overarching financial goals, your total savings, expected income changes and current living expenses. A qualified home lending advisor can provide more personalized guidance to help you find a mortgage that fits.
5. What are the risks of allocating too much income to mortgage?
Allocating too much income to a mortgage often causes financial strain, limits flexibility, and may lead to new debt. This over allocation of income toward a mortgage is sometimes called “house poor.” Higher payments leave less for other expenses and emergencies, potentially resulting in further borrowing and additional stress.
