What Percentage of Income Should Go Toward a Mortgage?

A comprehensive guide to calculating your mortgage budget

Fact checked by Betsy Petrick

If you are thinking of buying a home, you’ve probably heard the question “How much house can I afford?” The answer depends on your personal financial situation and your mortgage options.

What is the maximum percentage of your income that you should earmark for a monthly mortgage payment? This article looks at how mortgage payments are calculated and explains the common 28/36 rule that many lenders use to determine how much you can afford to pay. The 28 and 36 specifically refer to the fact that lenders recommend that you not devote more than 28% of your gross yearly income toward a mortgage or more than 36% of your gross income to all debts, including a mortgage.

Key Takeaways

• The 28/36 rule is a widely used guideline for determining mortgage affordability.
• Factors such as your income, your debt-to-income ratio, how large a down payment you can afford, and prevailing interest rates at the time can all play a role in determining how much you can borrow and how large your mortgage payments will be.
• In addition to your mortgage payment, homeownership involves costs like maintenance, property taxes, and insurance that you’ll want to take into consideration.
• Many resources are available online to assist in calculating mortgage affordability.

Understanding Mortgage Payments

Mortgage payments often consist of four main components:

• Principal. The principal of a loan is the original amount you borrow. For example, if you borrow $200,000, the principal is $200,000. Each month, a portion of your mortgage payment will go toward repaying that principal, with another portion going to interest.
• Interest. When you take out a mortgage, your lender charges interest. Your mortgage interest will be calculated as a percentage of the loan. The higher the interest rate, the higher your mortgage payment will be.
• Taxes. On top of the principal and interest, the lender may require you to pay an additional amount to cover your property taxes. The money will go into an escrow account, from which the lender will pay the tax bill when it comes due.
• Insurance. Your lender may also require you to contribute to an escrow account to cover your homeowners insurance premiums. If you make a down payment of less than 20%, your mortgage payment will most likely include private mortgage insurance (PMI), as well.

You’ll want to consider how all of these costs add up when you consider mortgage affordability.

The 28/36 Rule

The 28/36 rule is a common approach used to help determine how much debt an individual or household can safely assume.

Consumer Financial Protection Bureau. “How Does My Credit Score Affect My Ability to Get a Mortgage Loan?” According to the second part of the rule, you should spend a maximum of 36% of your monthly income on debt payments, including your mortgage.

Many lenders will use the 28/36 rule when considering your application for a mortgage.

Factors Influencing Mortgage Affordability

A number of factors come into play in determining how much you can afford when it comes to a mortgage.

Income Stability

Your income is a crucial factor mortgage lenders consider. Do you earn enough money to repay what you borrow?

Mortgage lenders also want to ascertain your income stability. Will you continue to earn enough to repay your loan? Lenders may be looking for a two-year history of consistent income to determine that your income is stable.

Debt-to-Income Ratio

Your debt-to-income (DTI) ratio is another important indicator of your financial health. DTI is the percentage of your gross monthly income that you use to pay back debt, including your mortgage and other debt, such as credit cards, auto loans, and student loans.

Lenders typically want to see a DTI of 36% or lower (remember the 28/36 rule), but some will consider a DTI of 43% or even higher.

Interest Rates

Your mortgage’s interest rate has a significant influence on your monthly payments. Interest rates fluctuate as economic conditions change. The average 30-year fixed mortgage interest rate was 7.49% as of April 25, 2024, according to Investopedia’s calculations. Individual factors, such as your credit score, will also affect the interest rate you may be offered.

Some mortgages have fixed interest rates that never change while other have adjustable rates than can go up or down over time.

Down Payment

A home is a large purchase. Buyers typically pay an upfront sum, the down payment, and take out a mortgage to finance the rest. Your down payment is calculated as a percentage of the total home cost. While a 20% down payment was once standard, the average down payment for first-time homebuyers was 6% in 2022.

A lower down payment can make homeownership more accessible, but there are benefits to larger down payments. For example, a bigger down payment can result in lower borrowing costs over time.

Calculating Your Mortgage Affordability

What is your mortgage affordability? Consider your:

• Home price. How much are you planning to spend on a home?
• Down payment. How much do you have saved up for a down payment?
• Loan term. Common loan terms are 30-year, 15-year, and 10-year. The longer the term, the lower your monthly payments, but the more you will pay in total over time.
• Interest rate.You can get an idea of your likely interest rate if you prequalify for a mortgage, or you can use your credit score to get an estimated interest rate.
• Taxes and insurance. Consider how taxes and insurance will add to your total monthly mortgage payment.
• Income. Once you have a monthly estimated mortgage payment, take a look at your income. Do you fit the 28/36 rule?

If your housing and debt payments would exceed the 28/36 guideline, lenders may be less likely to offer you a mortgage or more likely to charge higher interest rates if they do.

Considerations Beyond the Mortgage Payment

While your mortgage payment will be a considerable line item in your budget, it is not the only cost that comes with homeownership. You’ll also want to make sure you can afford items like these:

Maintenance

A home is an investment and one that requires maintenance. Smaller, routine maintenance, as well as big unexpected repairs, will be your responsibility. Setting aside 1% to 4% of your home’s value each year can help create a fund for maintenance.

Property Taxes and Insurance

Monthly mortgage payments often include property taxes and homeowners insurance. But if your lender does not put funds for taxes and insurance into escrow, you will need to budget for those expenses in addition to your mortgage payment.

Lifestyle and Financial Goals

Homeownership is a major milestone that many people aspire to reach, but it probably isn’t your only financial goal. How will your mortgage payment affect your lifestyle and financial goals? For example, will your mortgage payment prevent you from traveling as often as you would like?

Tools and Resources for Calculating Mortgage Affordability

There are many tools available to help you determine your mortgage affordability.

With the Investopedia mortgage calculator, for example, you can input your home price, down payment, loan term, and interest rate or credit score. The result will give you an idea of what your monthly payment, including principal and interest, property taxes, and homeowners insurance, could look like.

Other helpful resources include:

• Federal Deposit Insurance Corporation (FDIC) Affordable Mortgage Lending Center
• MyHome by Freddie Mac Homebuying Budget Calculator
• Fannie Mae Mortgage Affordability Calculator

What Are Some Common Mistakes People Make When Allocating Income Toward a Mortgage?

Your mortgage payment is a big expense, but some prospective homeowners forget to take the cost of home maintenance into consideration.

Neglecting to shop around for mortgage rates is another common mistake. Comparing different offers can help you get the best rate, cutting your monthly payments and saving you money in the long run.

How Can Changes in Interest Rates Affect My Mortgage Affordability Over Time?

Mortgage interest rates can be fixed or adjustable. With a fixed-rate mortgage, your interest rate will stay the same for the entire life of the loan.

With an adjustable-rate mortgage (ARM), however, your interest rate is variable. It can go up or down depending on current market trends. If your interest rate goes up, your monthly mortgage payments will also increase.

Are There Any Exceptions to the 28/36 Rule That Might Apply to Certain Financial Situations?

While lenders often use the 28/36 rule to guide their lending decisions, it isn’t necessarily set in stone. Some may have higher or lower percentage rules. If you have a high credit score, lenders may be more willing to offer you a mortgage when you have a higher DTI.

How Should I Adjust My Mortgage Budget if I Expect Changes in My Income or Expenses?

If you expect your income to decrease or your expenses to increase, consider whether your mortgage will still be affordable under those conditions. You may need to look for ways to boost your income or cut your expenses. Or you may want to borrow less at the outset.

Can Refinancing My Mortgage Affect How Much of My Income Should Go Toward It?

Refinancing your mortgage can potentially result in a lower interest rate and lower monthly payment.

The Bottom Line

Buying a home is a big decision. Your personal financial situation and the general economic conditions at the time will determine your mortgage affordability. Carefully consider both your mortgage payment and all the other costs of homeownership in relation to your income. Talking to a financial advisor about your budget and long-term financial goals can also help you navigate the home buying and borrowing process.

Read the original article on Investopedia.