What percentage of gross income should go to mortgage

You’ve run the numbers to determine how much house you can truly afford. That’s great! But now comes the hard part: actually finding a home that fits into your budget.

Here are some strategies to help stay on budget while searching for your next home.

Buy A Starter House Instead Of A Forever Home

In some cases, your budget might not be able to support your forever home dreams right now. And that’s OK! Instead of hunting in vain for a forever home that checks all of your boxes – including your budget – consider buying a starter home.

A starter home may be a bit smaller, older and closer to an area’s urban center than your dream home. But choosing to move forward with a starter home means that you’ll get into a home sooner and start putting money toward owning a property each month.

Once you, and your finances, are ready for your forever home, you’ll have plenty of options for your starter home. You could convert it into your first rental property to produce an income while upgrading your home. Or you could sell the starter home and funnel any proceeds into the equity of your next home.

Pay Down Your Debt

If you want to increase the amount of house you can afford, then paying down your existing debts can make a big difference. Of course, paying down debt can be easier said than done. But with regular action, you might be surprised by the dent you can make.

If possible, hold off applying for preapproval until you pay down the debts that are within reach. This strategy comes with three major benefits.

First, you’ll have some of the debts holding back your finances cleared from the books. Second, a decrease in your monthly debts will lead to an increase in the percentage of your monthly income that can be allocated towards your mortgage payment.

Finally, paying down debts will increase your overall financial health and potentially increase your credit score, making lenders more willing to approve your loan. Plus, you may even be able to unlock a better interest rate. A lower interest rate means that more of your mortgage payment can go towards your loan's principal, leading to a potentially larger loan amount.

If you are interested in tackling this strategy head-on, then learn how to pay off debt fast.

Wait

Waiting to purchase a home might not be the ideal choice. But time can make all the difference. If you are willing to hold off on your home purchase, many things could change between now and then.

For example, you might find a way to increase your income. That would allow you to qualify for a larger loan. Plus, the increased income would make saving for a larger down payment more feasible.

Additionally, waiting can give you the time you need to pay off your debts. That could significantly impact the amount of home you can afford.

Banks might approve mortgage payments up to 35% of your pretax income. Uber-conservative financial gurus advise limiting payments to less than 25% of your after-tax income. My middle-ground approach is to keep mortgage payments below 28% of your pretax income.

These questions often come up among first-time homebuyers:

  • What percentage of my monthly income can I afford to spend on my mortgage payment?
  • Does that percentage include property taxes, private mortgage insurance (PMI), or homeowners insurance?

Today I’ll tackle these questions to help make your home buying experience a little easier.

  • Consider Your Total Housing Payment, Not Just the Mortgage
  • What Others Say
  • My Take: Somewhere in Between
  • How to Lower Your Mortgage Payment
  • Finding the Right Lender
  • FAQs
  • Summary

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 property taxes and all housing-related insurance — homeowner’s insurance and PMI.

What percentage of your income should that housing budget be? It all depends on who you ask.

What Others Say

The Traditional Model: 35% or 45% of Pretax Income

In an article on how the mortgage crash of the late 2000s changed the rules for first-time homebuyers, the New York Times reported:

“If you’re determined to be truly conservative, don’t spend more than about 35% of your pretax income on mortgage, property tax, and home insurance payments. Bank of America, which adheres to the guidelines that Fannie Mae and Freddie Mac set, will let your total debt (including student and other loans) hit 45% of your pretax income, but no more.”

I would hardly call 35% of your pretax income conservative, let alone ‘truly conservative.’

Let’s remember that even in the post-crisis lending world, mortgage lenders want to approve creditworthy borrowers for the largest mortgage possible. So when you obtain mortgage pre-approval, lenders will likely approve you for a loan amount with payments of up to 35% of your pretax income. That may tempt you to take on more home than you should. But don’t just assume that because the bank approved it, you can afford it. They are two very different things.

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% of your pretax income today, but what about when you have kids, buy a new car, or lose your job?

The Conservative Model: 25% of After-Tax Income

On the flip side, debt-despising Dave Ramsey wants your housing payment (including property taxes and insurance) to be no more than 25% of your after-tax income.

“Your mortgage payment should not be more than 25% 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% of your take-home pay would give you. But it’s really not wise to spend more on a house because then you will be what I call “house poor.” Too much 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 Ramsey says 25% of your after-tax income while lenders are saying 35% of your pretax income. That’s a huge difference! Ramsey also recommends 15-year mortgages in a world where most buyers take 30-year mortgages. This is what I’d call conservative.

Another reader put it this way:

  • 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.

That’s on the conservative side, too. One week’s paycheck is about 23% of your monthly (after-tax) income.

My Take: Somewhere in Between

Not everybody is as debt-averse as Ramsey. And his one-size-fits-all advice might shut out a huge segment of Americans from ever realizing their homeownership dreams.

Good luck finding a mortgage in California that you can pay off over a 15-year term, with monthly payments at less than 25% of your after-tax income. That approach will be unrealistic in a number of regional American housing markets with high home prices.

If I had to set a rule, it would be this:

  • Aim to keep your mortgage payment at or below 28% of your pretax monthly income.
  • Keep your total debt payments at or below 40% of your pretax monthly income.

Note that 40% should be a maximum. I recommend striving to keep total debt to a third of your pretax income, or 33%.

As some commenters have pointed out, while it may be possible to buy a decent home in a small midwestern town for $100,000 (and well within these ratios), buyers in New York or San Francisco will need to spend five times that amount just to get a hole in the wall. Yes, people tend to earn more in these high-cost-of-living areas, but not that much more. Does it mean they shouldn’t buy a home? Not necessarily. They’ll simply have to make trade-offs to buy in those areas.

How to Lower Your Mortgage Payment

Extend Your Mortgage Term

Choosing a longer mortgage term spreads your loan balance over more total payments, reducing the amount of each payment individually.

But remember, extending your term comes at a cost, as you’ll ultimately pay more in cumulative interest over the life of your loan.

Read more: 15-Year Mortgages vs. 30-Year Mortgages

Make a Bigger Down Payment

The bigger your down payment, the more equity you start off with in your home, and the lower your loan amount. A smaller loan = smaller monthly payments.

Plus, crossing the 20% down threshold means you don’t have to pay PMI, which will further reduce your combined housing costs.

Get a Better Interest Rate

The interest rate a lender offers you affects your monthly mortgage payment amount. If you nab a lower rate, you’ll make a lower monthly payment. Your chances of getting a better interest rate might increase in a few different scenarios:

Average Interest Rates Are Low

Average mortgage interest rates vary substantially from year to year, and have at times varied by as much as 2% within a mere six-month period.

Getting a fixed-rate mortgage at a time when interest rates are low can keep your monthly payments low.

Read more: Mortgage Rates Briefly Explained

Your Credit Score Increases

One surefire way to score a better interest rate is to improve your credit score. If you haven’t applied for a mortgage yet and your score has room for improvement, it might be worthwhile to wait six months or so for your credit score to climb up before you go for the mortgage.

If you already have a mortgage and your credit score has improved significantly since you originally took out the loan, you might be able to refinance for a better rate.

Read more: How Much Does a 1% Difference in Your Mortgage Rate Matter?

You Shop Around

There are oodles of options out there for mortgage lenders. Signing with your historical bank might give you the comfort and trust of familiarity, but it won’t necessarily give you the lowest rate you can find.

Always compare your bank’s offer with competing banks, credit unions, and reputable online lenders.

Finding the Right Lender

One place to start is with Credible, a site that allows you to get quotes from three lenders in only three minutes. There’s no obligation, but if you see a rate you like for your mortgage or refinancing your mortgage, you can progress to the next step of the application process. Everything is handled through the website, including uploading documents. If you want to speak to a loan officer, you can, of course, but it isn’t necessary. 

As you shop for a lender, remember that every dollar counts. You’re committing to a monthly mortgage payment based on the rate you choose at the very start. Even small savings on your interest rate will add up over the years you’re in your house. 

Fiona is another great place to get started since they allow you to shop and compare multiple rates and quotes with minimal information, all in one place. You’ll input the amount of the loan, your down payment, state, mortgage product type, and your credit score to get mortgage quotes from multiple lenders at once.

FAQs

Can I Get a Mortgage If I Have Debt?

Having some degree of debt — like an auto loan — doesn’t disqualify you from getting a mortgage. But your DTI (debt-to-income ratio) certainly will influence how a lender evaluates your loan application. Generally speaking, a lender won’t approve you for a mortgage if your DTI is above 43%.

Personally, I advise you to hold off on a mortgage until your DTI is below 40% max. And a 33% DTI is an even better goal before applying for a mortgage. Going into a mortgage with a lower DTI gives you more financial breathing room in the event that unexpected expenses pop up.

What Is ‘House Poor’?

House poor is a financial circumstance in which a mortgager allocates too large a portion of their income toward homeownership expenses. This leaves the mortgager unable to live comfortably, and also puts them at risk of being unable to reach other financial goals.

Summary

Some financial gurus might say that the less of your income you devote to mortgage payments, the better. But taking an excessively conservative approach to mortgage payments might saddle you with a house or neighborhood that you’re unhappy with. On the other side of the spectrum, devoting too much of your income to your mortgage can put you in a financially vulnerable position, with little expendable income.

My broad guideline is to keep your monthly mortgage payment — including insurance and property taxes — at 28% of your pretax income. And try to keep your total debt payments, mortgage included, as close to 33% of your pretax income as possible.

There’s really no one-size-fits-all solution to mortgage budgeting. But you can start with my middle-ground approach and tailor it to align with your future financial goals and local housing market.

Read more:

  • First-Time Home Buying Guide
  • How Much House Can You Afford?

Credible Operations, Inc. NMLS# 1681276, “Credible.” Not available in all states. www.nmlsconsumeraccess.org.” Credible Credit Disclosure - To check the rates and terms you qualify for, Credible or our partner lender(s) conduct a soft credit pull that will not affect your credit score. However, when you apply for credit, your full credit report from one or more consumer reporting agencies will be requested, which is considered a hard credit pull and will affect your credit.

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What is the 28th 36% rule?

According to this rule, a household should spend a maximum of 28% of its gross monthly income on total housing expenses and no more than 36% on total debt service, including housing and other debt such as car loans and credit cards.

What percentage of income should go to mortgage Ramsey?

Figure out 25% of your take-home pay. To calculate how much house you can afford, use the 25% rule: Never spend more than 25% of your monthly take-home pay (after tax) on monthly mortgage payments.

What percentage of income should go to mortgage and utilities?

The most common rule of thumb to determine how much you can afford to spend on housing is that it should be no more than 30% of your gross monthly income, which is your total income before taxes or other deductions are taken out. For renters, that 30% includes rent and utility costs like heat, water and electricity.

How much should I spend on a house if I make $100 K?

A 100K salary means you can afford a $350,000 to $500,000 house, assuming you stick with the 28% rule that most experts recommend. This would mean you would spend around $2,300 per month on your house and have a down payment of 5% to 20%.