What Percentage of Your Income Should Go to Mortgage Payments?

Preparing to buy a home and pay for a mortgage is a big financial leap. Whether you're buying your first home or searching for your dream home, the expenses that go into purchasing a home are high. From down payment to closing costs, you'll need to prepare for many payments. Beyond that, the monthly mortgage payments should be affordable for your income and lifestyle. If you have extra major expenses, that can significantly limit your purchasing power. Read on to understand what percentage of income should go to mortgage payments.

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5 Common Mortgage Payment Rules and Models

There are no one-size-fits-all mortgage rules, although you could apply five common mortgage payment rules and models to your situation. 

28% Rule 

The 28% rule is the most common housing payment calculation. The 28% rule suggests you should not spend more than 28% of your gross income on housing payments. In this case, the housing payment encompasses the mortgage with principal and interest as well as taxes and insurance.

For example, if you make $10,000 per month in gross income, you shouldn't spend more than $2,800 per month on a mortgage plus insurance and taxes. If your gross income is $6,000, that would drop to $1,680

28% / 36% Rule 

The 28% / 36% rule is the same as the 28% rule but also considers other debt. The 28% part of the rule is the same, while the 36% states that you shouldn't spend more than 36% of your gross income on all debts combined, including mortgage, student loans, auto loans and any other debt obligations. 

For example, if you make $10,000 per month and have a mortgage including insurance and taxes of $2,800, your total other debt shouldn't be more than $800. If you have a $400 monthly car payment and a $400 student loan repayment, you're at the maximum of $3,600.

43% Debt-to-Income (DTI) Ratio

Lenders often use the 43% debt-to-income (DTI) ratio to assess borrowers' ability to repay a loan. By this rule, 43% is the maximum total debt a borrower should have, calculated as a percentage of gross income. While lenders generally seek ratios of no more than 36%, a DTI of 43% is typically the highest ratio a borrower can have and still qualify for a mortgage.

For example, if you and your spouse make a combined $10,000 per month, a lender applying the 43% DTI rule would look at all your other debt and then approve a mortgage up to the amount that would equal 43%. If 10% of your income is going to other debt repayments, a lender would approve a mortgage with insurance and taxes up to $3,300.

35% / 45% Model

The 35% / 45% model is another option to calculate your maximum housing payment. The 35% / 45% model takes into account your post-tax income. In other words, it suggests that your housing payment shouldn't be more than 35% of your gross income or 45% of your net income after taxes.

If you have $10,000 in gross income but take home $7,500 after taxes, according to the 35% rule your housing payment shouldn't be more than $3,500. By the 45% part of the rule, you're housing payment shouldn't be more than $3,375 ($7,500 * 0.45 = $3,375).

25% Post-Tax Model

If you want a simple post-tax model, this is the option for you. Under the 25% post-tax model, you'll pay a maximum of 25% of your post-tax income toward housing. This model leads to lower total housing costs compared to the other models. However, if you prefer to keep housing costs lower so you can focus more on savings or other goals, this is a good option.

Suppose you make $10,000 per month. After taxes, you take home $7,500. By the 25% post-tax model, you could pay a maximum of $1,875 on housing costs. Whether this includes taxes and insurance is up to you. 

How Lenders Determine Your Mortgage Payment

Lenders look at a variety of factors to determine your available funds for a home loan. Factors they consider include:

Credit Score

Your credit score will impact your interest rate and the types of mortgage you can qualify for. For a conventional mortgage, most lenders require a minimum credit score of 620. Some lenders may accept lower credit scores of 580 or even 500 with a larger down payment. 

DTI Ratio 

Your total debt in relation to your income will also affect your mortgage eligibility. Lenders look for a DTI below 43% and ideally, below 36% including all housing costs.  

Income

Lenders consider your income stability in determining your mortgage payment. Lenders look at your income to calculate DTI and determine how much you can afford to spend on a home. 

Tips for Lowering Your Monthly Mortgage Payments

Lowering your monthly mortgage payment will give you wiggle room in your budget and the opportunity to save more. Here are steps you can take to lower your monthly mortgage payments. 

Refinance Your Mortgage at a Lower Interest Rate

Refinancing your mortgage is one of the best ways to lower monthly payments, assuming interest rates have dropped significantly. For example, a $250,000 mortgage at 7% interest will have a total monthly payment of $1,663. If the interest rates drop to 5%, your monthly payment could be reduced to just $1,342, a savings of about $320 per month. 

Extend the Loan Term 

If you speak to your lender about extending the loan term or refinancing with a longer loan term, you'll pay more in interest, but you'll save on total monthly payments. For example, if you plan to pay a $250,000, 7% interest loan in 15 years, the monthly payment will be $2,247. Increase the term to 30 years, and the payments drop by over $600 per month to $1,663.

Make a Larger Down Payment

Making a larger down payment will reduce the loan principal, reducing monthly costs. For example, if you make an extra $50,000 down payment on a $250,000 mortgage, your loan principal will be reduced to $200,000. Monthly payments will also be reduced from $1,663 to $1,330 (assuming a 7% interest rate). 

Consider a Loan Modification or Forbearance Program

You can also consider a forbearance agreement or loan modification agreement as a strategy that can help you reduce your monthly mortgage payments. A forbearance agreement provides short-term relief for a borrower with a temporary financial problem. This agreement is made with the mortgage lender. A loan modification agreement is a long-term solution, also made with the lender. However, some borrowers can be eligible for government assistance in loan modification.

Shop Around for the Best Mortgage Rates and Terms

The best way to reduce your monthly mortgage payments is to choose a lender with favorable interest rates and terms at the outset. Be sure to shop around and compare lender reviews, interest rates and annual percentage rates (APRs), which are more accurate than interest rates and all terms. Taking the time to research lenders ahead of time can lead to long-term mortgage savings. 

Compare the Best Mortgage Companies from Benzinga’s Top Providers

Ready to start comparing lenders? Find some of the best mortgage companies from Benzinga's top providers and check out their top offers today. 

Should You Stretch to Make Mortgage Payments?

While your home may be the largest single purchase you make in your lifetime, it's not a good idea to try to stretch your income to buy a bigger house than you can afford. Have you heard the term "house poor"? That's someone who lives in a big, beautiful home but doesn't have enough disposable income for discretionary expenses or, in some cases, essentials. 

To protect yourself financially, choose one of the formulas above, and stick to it. Long term, you can have more financial leeway to pay off the mortgage biweekly or make principal-only payments. You can also use those extra funds to build more retirement savings, an emergency fund and take fun vacations. 

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