When you buy a home, it’s important to know how much of your income you can reasonably dedicate to your monthly mortgage payment. Knowing this percent can mean the difference between living comfortably and meeting other financial priorities or being “house poor” and struggling to make ends meet.
What percentage of income should go to a mortgage?
Every borrower’s situation is different, but there are at least two schools of thought on how much of your income should be allocated to your mortgage: 28 percent and 36 percent.
The 28 percent rule, which specifies that no more than 28 percent of your income should be spent on your monthly mortgage payment, is a threshold most lenders adhere to, explains Corey Winograd, loan officer and managing director of East Coast Capital Corp., which has offices in New York and Florida.
“Most lenders follow the guideline that a borrower’s housing payment (including principal, interest, taxes and insurance) should not be higher than 28 percent of their pre-tax monthly gross income,” says Winograd. “Historically, borrowers who are within the 28 percent threshold generally have been able to comfortably make their monthly housing payments.”
This 28 percent cap centers on what’s known as the front-end ratio, or the borrower’s total housing costs compared to their income.
The 36 percent model is another way to determine how much of your income should go towards your mortgage, and can be used in conjunction with the 28 percent rule. With this method, no more than 36 percent of your monthly income should be allocated to your debt, including your mortgage and other obligations like auto or student loans and credit card payments. This percentage is known as the back-end ratio or your debt-to-income (DTI) ratio.
“Most responsible lenders follow a 36 percent back-end DTI ratio model, unless there are compensating factors,” Winograd says.
Note that there are maximum DTI ratios set by Fannie Mae, Freddie Mac and the FHA that lenders use in underwriting, as well. These are 45 percent (sometimes up to 50 percent) for conventional loans and 43 percent for FHA loans.
Example of mortgage payment percentage
Based on the 28 percent and 36 percent models, here’s a budgeting example assuming the borrower has a monthly income of $5,000.
- $5,000 x 0.28 (28%) = $1,400 (Maximum mortgage payment)
- $5,000 x 0.36 (36%) = $1,800 (Maximum debt obligation including mortgage payment)
Going by the 28 percent rule, the borrower should be able to reasonably afford a $1,400 mortgage payment. However, factoring in the 36 percent rule, the borrower would also only have room to devote $800 to their remaining debt obligations. Applied to your own financial situation, this may or may not be feasible for you.
The complete picture
As any homeowner can attest, the expenses of owning and maintaining a home can add up well beyond the monthly cost of a mortgage.
“HOA fees, utility payments and other expenses must be factored into the affordability calculation,” Winograd says.
These other costs can include:
- Home maintenance, including a fund for future replacement of things that wear out over time such as appliances, the roof and HVAC system
- Pest prevention
The kind of mortgage you choose can also have a significant impact on what you can afford. To find a loan that’s right for you, it’s important to explore all your options, including conventional, FHA and VA loans. It’s also smart to find a mortgage lender that understands your financial situation, needs and goals.
“An effective loan officer will spend the time to learn about a client’s current and future financial picture to determine a suitable loan product, loan amount and loan terms,” Winograd says.
You can work with your lender to do the affordability calculations based on your income and the cost of the home you have in mind, and from there, evaluate whether you can reasonably afford it. Remember that when it comes to estimating what you can afford, there are guidelines you can follow, but ultimately it’ll be based on your individual circumstances.
“There is no hard and fast rule because every borrower has a different story, a unique credit profile and varying debt obligations, all of which must inform the decision regarding the percentage of gross monthly income available for a housing payment,” Winograd says.