Your salary makes up a big part in determining how much house you can afford. On one hand, you may want to see how much you could afford with your current salary. Or, you may want to figure out how much income you need to afford the house you really want. Either way, this guide will help you determine how much of your income you should put toward your mortgage payments every month.
First: what is a mortgage payment?
Mortgage payments are the amount you pay lenders for the loan on your home or property, including principal and interest. Sometimes, these payments may also include property or real estate taxes, which increase the amount you pay. Typically, a mortgage payment goes toward your principal, interest, taxes and insurance.
Many homeowners make payments once a month. But there are other options, such as a twice a month or every two weeks.
Well-known mortgage payment rules or methods
There are several ways to determine how much of your salary should go towards your mortgage payments. Ultimately, what you can afford depends on your income, circumstances, financial goals and current debts. Here are some ways to calculate how much you can afford:
The 28% rule
The 28% rule states that you should spend 28% or less of your monthly gross income on your mortgage payment (e.g. principal, interest, taxes and insurance). To determine 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 35% / 45% model
With the 35% / 45% model, your total monthly debt, including your mortgage payment, shouldn't be more than 35% of your pre-tax income, or 45% more than your after-tax income. To calculate how much you can afford with this model, determine your gross income before taxes and multiply it by 35%. Then, multiply your monthly gross income after you've deducted taxes by 45%. The amount you can afford is the range between these two figures.
For example, let's say your 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. Given this information, you can afford between $3,500 - $3,600 per month. The 35% / 45% model gives you more money to spend on your monthly mortgage payments than other models.
The 25% post-tax model
This model states your total monthly debt should be 25% or less of your post-tax income. Let's say you earn $5,000 after taxes. To calculate how much you can afford with the 25% post-tax model, multiply $5,000 by 0.25. Using this model, you can spend up to $1,250 on your monthly mortgage payment. This model gives you less money to spend as opposed to other mortgage calculation models.
Though these models and rules can help you gauge what you can afford, you also need to keep your financial needs and goals in mind.
How do lenders determine what I can afford?
Whether you qualify for a mortgage depends on your mortgage lender's standards and requirements. Typically, lenders focus on three things: your gross income, your debt-to-income (DTI) ratio and your credit score. Here's an explanation of each and how to calculate them:
Gross income is the sum of all your wages, salaries, interest payments and other earnings before deductions such as taxes. While your net income accounts for your taxes and other deductions, your gross income does not. Lenders look at your gross income when determining how much of a monthly payment you can afford.
Debt-to-Income (DTI) ratio
While your gross income is an important part in determining how much you can afford, your DTI ratio also comes into play. Simply put, your DTI is how much you make versus how much debt you have. Lenders use your DTI ratio and your gross income to determine how much you can afford per month.
To determine your DTI ratio, take the sum of all your monthly debts such as revolving and installment debt payments, divide this figure by your gross monthly income and multiply by 100. If your DTI is on the higher end, you may not qualify for a loan because your debts may affect your ability to make your mortgage payments. If your ratio is lower, you may have an easier time getting a mortgage.
Your credit score is an important factor lenders use when deciding whether or not to offer you a loan. If you have a high debt-to-income ratio, your credit score may increase your chances of getting a loan because it shows you are able to handle a higher amount of debt. Different loans have different credit score requirements, so check with your lender to see if your score is where it needs to be.
Tips for lowering your monthly mortgage payments
If you're a first-time homebuyer, you may want to have a lower mortgage payment. here's some helpful advice on how to do that:
Increase your credit score.
The higher your credit score, the greater your chances are of getting a lower interest rate. To increase your credit score, pay your bills on time, pay off your debt and keep your overall balance low on each of your credit accounts. Don't close unused accounts as this can negatively impact your credit score.
Lengthen your mortgage term.
If your mortgage term is longer, your monthly payments will be smaller. Your payments are extended over a longer time, resulting in a lower monthly payment. Though this may increase how much interest you pay over time, it can help reduce your DTI.
Make a larger down payment.
Putting at least 20% down is common, but consider putting even more down to lower your monthly mortgage payment. The higher your down payment, the lower your monthly payment will be.
Eliminate your private mortgage insurance (PMI).
Before you purchase a home, try to save for a 20% down payment. This removes the need for PMI, which lenders typically add to your monthly mortgage payment.
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, which could lower your monthly mortgage payment.
Refinance your mortgage.
If interest rates have dropped, consider refinancing your mortgage. A lower interest rate could mean a lower monthly payment. Make sure your credit is in good standing before applying for a refinance.
Ultimately, how much you can afford depends on your particular situation and finances. Speak to a Home Lending Advisor or use our online mortgage calculator to help you determine what percentage of your salary should go towards a mortgage loan.