How much house can I afford with my current salary? It’s a valid question and a popular one. New homebuyers often ask, how much of my income should go toward a mortgage? The good news is this: you get to decide. Mortgage lenders have specific guidelines to evaluate risk. But they could also approve a home loan with a mortgage payment that is higher than you want.
Most homebuyers want a mortgage they can afford that fits their lifestyle.
After all, what happens if you qualify for a mortgage, but you’re strapped for cash once escrow closes? Today, many homebuyers seek financial stability, and few are willing to become house poor along the way.
If you’re looking to buy a home and want a mortgage that helps you achieve financial security, these guidelines can help.
How much of my income should go toward a mortgage?
Each financial situation is different, but here are some common guidelines. Some of these factors are used by mortgage lenders to help determine risk. But these guidelines are also incredibly helpful for homebuyers who want financial stability.
Even when you qualify for a high purchase amount, you can decide how much you’re willing to borrow.
The 28% Rule
The 28% rule is a common guideline used by mortgage lenders and financial advisors.
In short, to follow this rule, no more than 28% of your gross monthly income should go toward your mortgage payment.
In this scenario, your total monthly mortgage payment should be 28% or less than your pre-tax monthly gross income. For reference, your total mortgage payment threshold includes principal, interest, property taxes, and homeowner’s insurance.
For example, if your monthly gross income (pre-tax) is $6,500, then 28% would be $1,820. This is one way to decide what percentage of your income should go toward a mortgage.
Statistically, homebuyers who qualify for a mortgage using the 28% rule can make their mortgage payment more comfortably.
The 28% rule is also referred to as the front-end ratio: a borrower’s total housing costs as compared to their total pre-tax gross income.
The 36% Rule
The 36% rule compares your gross monthly income against your monthly debt obligations.
With this guideline, no more than 36% of your pre-tax gross monthly income is used to meet monthly debt obligations. To determine your monthly debt payments, simply add credit card payments, auto loans, student debt, etc.
Together with your monthly mortgage payment, total debt repayments should be 36% or less of your gross monthly income.
The 28%-36% combination can provide a solid financial picture when used together. It can also help you decide how much of your income should go toward a mortgage.
Using our example of $6,500 monthly gross income, 36% would be $2,340. The difference between 28% ($1,820) and 36% ($2,340) would leave $520 available for debt obligations.
Staying within these limits typically means you’ll be able to put aside savings for home maintenance and unexpected expenses without being cash strapped.
The 43% Debt-to-Income Ratio Formula
Most mortgage lenders offer the best rates to borrowers with a DTI ratio of <36%.
However, qualified borrowers can get mortgage approvals with a DTI (debt-to-income) ratio up to 43%.
Worth noting–a higher DTI ratio often leads to a higher mortgage rate depending on the mortgage lender. Or less than favorable loan terms.
If you qualify for a mortgage with a DTI near 43-45%, beware that you may have a mortgage payment that is difficult to repay. If your financial profile changes or employment shifts, you’ll still need to make your monthly mortgage payment.
If almost 50% of your income goes toward a mortgage payment, this might add financial stress.
When comparing your finances, make sure you take time to look at the whole picture. For example, even if you get approved, you might not want a home loan and a mortgage payment that adds stress in the long run.
The 25% Post-Tax Model
The 25% model is a different way to compare your debt obligations to determine how much you can afford.
Instead of using pre-tax gross income for this model, homebuyers look at their take-home pay. This is your monthly income after taxes.
In this example, if your monthly take-home pay is $6,500, then 25% would be $1,625. This is the amount of your income that would go toward a mortgage.
Mortgage lenders evaluate risk largely based on the rules and guidelines listed above. In addition, a few major factors affect the mortgage approval process. For example, lenders will consider your credit history, credit score, and employment history. In addition, you’ll need to verify current income and list any additional income sources (e.g., investment income, self-employment, spousal support, rental income).
If you’re considering buying a new home, take time to look at your whole financial picture. Think about your lifestyle, how much you want to save and invest, and how you’ll prepare for the unexpected.
Ultimately, you can decide what percentage of your income should go toward a mortgage. Connect with a local mortgage advisor to discuss your goals. The right mortgage can help you build financial security and help you build wealth and stability. We’d love to help.