What percentage of your income can you afford for mortgage payments? Do you use gross monthly income or take-home pay? Learn how much house you can afford with simple rules based on your monthly income.
These questions often come up among first-time home buyers:
What percentage of my monthly income can I afford to spend on my mortgage payment?
Does that percentage include homeowners insurance?
Today we tackle these questions to help make your home buying experience a little easier.
Rule 1: Consider your total housing payment, not just the mortgage
Most agree that your housing budget should encompass not only your mortgage payment (or rent, for that matter), but also all housing-related insurance.
As for just how big a percentage of your income that housing budget should be? It all depends on whom you ask.
What most people say
The traditional model: 35 percent/45 percent of pretax income.
Always remember lenders want to lend you as much as possible! Although most people would say that 35%-45% of your pre-income being spent on mortgage payments is conservative we beg to differ. Given that this is before you pay taxes and it accounts for such a large portion of your income we consider it average at best.
The conservative model: 25 percent of after-tax income!
On the flip side, Conservative financial advisors say that your housing payment (including property taxes and insurance) should be no more than 25 percent of your take-home income.
Your mortgage payment should not be more than 25 percent of your take-home pay and you should get a 15-year or less, fixed-rate mortgage … Now, you can probably qualify for a much larger loan than what 25 percent of your take-home pay would give you. However this will mean a large portion of your income would be going out in payments, and it will put a strain on the rest of your budget so you wouldn’t be saving and paying cash for furniture, cars, and education.
Notice that financial advisors are saying 25 percent of your after tax income while lenders are saying 35 percent of your pretax income. That’s a huge difference! Also, most lenders would push you towards 30 year mortgages. Although you can afford this, it really prohibits your ability to save. We advise going with a 15-year mortgages. This is what we would call conservative.
Our take: Somewhere in between
Not everybody is as debt-averse as financial advisors—and following his one-size-fits-all advice has risks. You just have to remember: The more you spend on your home, the less you have available to save for everything else. You may be able to afford a housing payment that is 35 percent of your pretax income today, but what about when you have kids, buy a new car, or lose your job?
Another way to think about it is like this:
- Your mortgage payment should be equal to one week’s paycheck.
- Your mortgage payment plus all other debt should be no greater than two weeks’ paycheck
If we had to set a rule, it would be this:
Aim to keep your mortgage payment at or below 28 percent of your pretax monthly income.
Aim to keep your total debt payments at or below 40 percent of your pretax monthly income. Note that 40 percent should be a maximum. We recommend an even better goal is to keep total debt to a third, or 33 percent. (remember total debt includes house, car and any other debt payments.
Just remember that when you obtain mortgage pre-approval, lenders will likely approve you for a loan amount with payments of up to 40 or 45 percent of your pretax income. That may tempt you to take on more home than you should. Don’t just assume that just because the bank approved it, you can afford it. They are two very different things.