What Percentage of Your Income Should Go to Your Mortgage?
Buying a home is one of the biggest financial decisions you’ll ever make. But how do you figure out what you can afford without stretching your budget too thin? It all comes down to the percentage of your income you dedicate to your mortgage payment.
Whether you’re saving for your first home or considering refinancing for better terms, finding the right balance between your income and monthly mortgage payment is key to feeling financially secure.
Ready to explore ways to refinance your mortgage and lower your monthly payment? Check out Rate’s mortgage refinance options to get started today!
What Percentage of Your Income Should Go to Your Mortgage?
Most lenders use this rule to determine how much mortgage you can afford based on your income, debts, and expenses. These rules are guidelines, not one-size-fits-all formulas, but they give home buyers a good starting point. Here are some of the most widely used models:
The 28% / 36% Rule
If you’ve ever looked into how much home you can afford, you’ve probably come across the 28% / 36% rule. This is one of the most widely used guidelines among mortgage lenders.
The idea is simple: your monthly housing payment, which includes your principal, interest, property taxes, and homeowners insurance, shouldn’t exceed 28% of your gross monthly income.
On top of that, your total monthly debt payments, including credit cards, auto loans, and student loans, should stay under 36% of your gross monthly income. These two percentages are referred to as your front-end and back-end ratios.
For example, if your gross monthly income is $6,000, your housing costs shouldn’t exceed $1,680, and your total debt obligations should stay below $2,160. Lenders use these ratios to ensure you’re not taking on too much debt, reducing the risk of financial hardship.
The 35% / 45% Rule
If you have a strong credit score or a higher gross annual income, you may qualify for more flexible guidelines like the 35% / 45% rule. This allows you to dedicate up to 35% of your pre-tax monthly income to housing costs and up to 45% to total debt payments.
While this approach lets you afford more house, it’s not for everyone. It works best for borrowers with stable, high-paying jobs who can handle additional expenses like real estate taxes and maintenance costs without dipping into their savings.
The 25% Rule
If you’re the type who likes to play it safe, the 25% rule might be a better fit. This model suggests that no more than 25% of your take-home pay (your income after taxes) should go toward housing expenses.
This approach keeps your budget flexible, leaving room for things like unexpected medical bills, child support, or even that summer vacation you’ve been planning. While it might limit how much mortgage you qualify for, it’s a solid choice for long-term financial stability.
How Are Monthly Mortgage Payments Determined?
When lenders calculate your monthly mortgage payment, they don’t just focus on the home’s price. Instead, they consider a mix of financial factors to determine how much money you can realistically borrow. Here’s what goes into that calculation:
Gross Income
Your gross monthly income—what you earn before taxes and deductions—is the foundation of every lender’s affordability model. It gives lenders a clear picture of your financial capacity and helps them estimate how much home you can afford.
Credit Score
A good credit score can be your ticket to lower interest rates, which means a smaller monthly mortgage payment. On the flip side, borrowers with lower credit scores may face higher interest rates, driving up their housing costs.
If you’re worried about higher interest rates, improving your credit score before applying for a mortgage is one of the best ways to reduce your monthly payment.
Debt-to-Income (DTI) Ratio
DTI is a major factor lenders use to evaluate your financial situation. It compares your total monthly debt payments, like credit card debt, car loans, and student loans, to your gross monthly income.
- Front-end ratio: This is the percentage of your gross income that goes toward housing costs, including your mortgage payment, property taxes, and homeowners insurance
- Back-end ratio: This includes all your monthly debt obligations, from auto loans to personal loans, credit card payments, and more.
Lenders generally prefer borrowers with a lower DTI ratio because it shows you’re not overstretching your budget. If you’re looking for ways to lower your DTI ratio, paying off some existing debt, like credit card balances or auto loans, can help.
Job History
Consistency is key when it comes to your income. Lenders want to see a steady job history because it shows you can handle monthly mortgage payments long-term. If you’ve recently switched careers or have gaps in your employment, that could affect your loan eligibility.
Interest Rates and Loan Terms
Your loan’s interest rate and term length (e.g., 15 years vs. 30 years) play a big role in determining your monthly payment. A lower interest rate means less money paid over the life of the loan, while longer loan terms spread out payments to make them more manageable.
Additional Factors
Lenders also consider things like property taxes, escrow account contributions, and homeowners insurance. These costs are often bundled into your monthly payment, so it’s essential to factor them into your budget.
For instance, real estate taxes and maintenance costs can vary widely depending on where you live, so always include those expenses when calculating how much home you can afford.
How To Lower Monthly Mortgage Payments
If your current or potential mortgage payment feels too high, there are ways to reduce it. Here are some practical strategies:
Refinance
Refinancing is one of the most effective ways to lower your monthly housing payment. If interest rates have dropped since you first took out your loan, refinancing to a lower rate could significantly reduce your costs.
You might also consider switching from a 15-year mortgage to a 30-year conventional loan to stretch your payments over a longer period. While this approach lowers your monthly payment, it does mean paying more in interest over time. Still, for borrowers needing immediate relief, it’s often a smart move.
Extend Your Loan Term
Extending your loan term can feel like a financial reset. By choosing a longer loan term, you can spread your mortgage amount over more months, resulting in smaller payments.
This option is particularly helpful if your monthly income has been stretched thin by other expenses, such as credit card debt, student loans, or unexpected costs. Just keep in mind that the longer the loan term, the more interest you’ll pay over time.
Get Rid of Private Mortgage Insurance (PMI)
Private mortgage insurance (PMI) is often required if your down payment is less than 20%. Over time, as you pay down your mortgage and build equity, you can request your lender to remove PMI.
For many homeowners, this simple step can save hundreds of dollars every month. It’s a great way to make homeownership more affordable without needing to refinance or restructure your loan.
Lower Your Home Insurance Rate
Your home insurance premium is included in your escrow account and directly affects your monthly payment. If you haven’t shopped around for insurance in a while, it might be worth it.
Many insurance providers offer discounts for bundling auto and home policies, installing security systems, or making certain home improvements. Every little bit counts when it comes to lowering costs.
Improve Your Credit Score
A better credit score can unlock more favorable mortgage terms, including a lower interest rate. If your financial situation has improved since you first secured your loan, it might be time to revisit your options.
Lenders view borrowers with higher credit scores as lower risk, which often translates to better rates and lower monthly payments. Even small improvements to your score can make a difference in the long run.
Pay A Bigger Down Payment
If you’re in the market for a new home, putting down a larger down payment is one of the best ways to lower your monthly mortgage payment. A bigger down payment reduces the loan amount, and in some cases, might even help you secure a lower rate.
For first-time homebuyers, programs like Fannie Mae’s HomeReady mortgage offer flexibility, making homeownership possible even if you can’t reach the traditional 20%.
Appeal Your Property Tax Assessment
Property taxes can add a significant amount to your monthly payment. If you think your property has been overvalued, consider appealing the assessment.
It’s a process that varies by location, but if successful, it could lower your taxes and, in turn, reduce your escrow payment. This is especially helpful for homeowners whose monthly housing payment feels too high.
Consider A Biweekly Payment Plan
Switching to a biweekly payment schedule is another way to save on interest and reduce your overall loan balance. By making half-payments every two weeks instead of one full payment each month, you’ll end up making an extra payment each year.
Over time, this can shorten your loan term and save you thousands in interest without drastically changing your monthly budget.
What Happens If I Spend More Than the Recommended Percentage of My Income on a Mortgage
Spending more than the general rule of thumb can lead to financial hardship. It leaves less money for other expenses, like savings, emergencies, and maintenance costs, which can strain your budget over time.
Take Control of Your Mortgage Today
Knowing how much of your income to dedicate to your mortgage is a crucial step toward smart homeownership. By understanding your budget and following key guidelines, you can avoid financial stress and plan confidently for the future.
If you’re ready to lower your monthly payment or adjust your mortgage terms, Rate’s mortgage refinance options make it easy to find a solution that fits your life. With competitive rates and a seamless process, we’re here to help you save money and reach your financial goals. Start exploring your options today with Rate’s Mortgage Refinance!