What Percentage of Your Income Should Go Toward Your Mortgage?

Learn About Suggested Mortgage Income Guidelines

You don't want to buy more home than you can comfortably afford. If you do, you might find yourself struggling to make mortgage payments and compromising on other financial goals.  But if you keep your payments below a certain percentage of your income, this is less likely to be an issue.

This article will explain what costs to keep in mind when buying a home and three common guidelines for affordability, including the popular 28/36 rule.

What Is the 28/36 Rule for Mortgage Affordability?

The 28/36 rule says you can devote up to 28% of your income to housing costs and 36% to all debt. Keeping costs below these percentages recommended by financial experts means you'll ideally have a stable budget. Lenders also often use these guidelines when considering eligibility.. Here's how they work.

• 28% “front-end” ratio: Total monthly housing costs should be capped at 28%, including mortgage principal and interest, taxes, insurance (PITI) and HOA fees.
• 36% "back-end" ratio: Total debt, including PITI as well as things like car loans and student loans, should be capped at 36% of income.

The 28% Front-End Ratio

Many mortgage lenders use the 28% guideline when deciding how much money you can borrow to finance a home.

This guideline states that you should spend no more than 28% of your monthly gross income on your mortgage payment, which includes principal, interest, property taxes, homeowners' insurance, and mortgage insurance (if your loan requires it).

For example, if your monthly gross income is $10,000, then your housing costs should be no more than $2,800 a month, according to the 28% guideline.

The 36% Back-End Ratio

Lenders also often use a 36% guideline when they are making approval and offer decisions. The 36% guideline states that the total monthly cost of all your debt payments, including your mortgage, should be no more than 36% of your monthly gross income. This ratio is also referred to as your debt-to-income ratio (DTI).

Following this concept, if your monthly gross income is $10,000, and you make monthly payments on a car and student loans, as well as your mortgage, the total cost of all these debt payments should be no more than $3,600. However, keep in mind that DTI requirements vary by lender. Some may accept a DTI ratio of up to 43%, for example.

Are the 28% and 36% Income Guidelines Official Rules?

The 28/36 income guidelines are not official rules that mortgage lenders are required to follow.

However, there are good guidelines to consider when setting expectations around approval and affordability. Lenders, including Freedom Mortgage, look at your income, credit history, and finances when reviewing your application and may approve mortgages that end up higher or lower than the 28/36 suggestion.

What Is The 35/45 Rule?

The 35/45 rule caps total debt payments, including your mortgage, at 35% of pre-tax income or 45% of after-tax income. This rule offers more flexibility than the classic 28% and 36% ratios and can make sense for higher earners who may be able to spend a larger percentage of income on their housing without jeopardizing their ability to afford the essentials.

What Is The 25% Post-Tax Model?

Finally, the 25% post-tax model says you should not spend more than 25% of your post-tax income on housing costs. This is a more conservative rule that is focused on making sure you have enough money to accomplish other goals. If you have a limited income or want to accomplish other big goals like saving for an early retirement, this approach may be best.

What Costs Influence Your Mortgage Payment?

When you're trying to limit your mortgage payment to a reasonable percentage of income, it's helpful to understand what costs influence your payment amount. That way, you'll know what changes you may need to make to ensure your payment is affordable.

Here are the key factors that determine the monthly cost of your mortgage:

• Principal: A portion of each monthly payment goes toward repaying principal, reducing your loan balance.
• Interest: Part of your monthly payment goes toward interest, which is the cost of borrowing.
• Taxes: Most mortgage lenders require you to pay a portion of your property taxes each month, which is then put into an escrow account for when your taxes are due.
• Insurance: Many mortgage lenders also require you to pay a portion of your homeowner's insurance costs into an escrow account each month.

Other Home Affordability Considerations

There are also many other factors affecting home affordability, including the following:

• Costs of homeownership: Beyond your mortgage, you'll also have to pay for things like moving costs, utility bills in your new home, and home maintenance.
• Mortgage type: Some mortgages have lower interest rates than others and may allow you to make a smaller down payment. Both FHA and VA loan options tend to be more affordable than conventional loans for people with lower credit scores and without a lot of money to put down.
• Current housing market: In some markets, housing comes at a higher price. You'll need to consider your local market when deciding how much house you can afford.
• Mortgage rate changes: Mortgage rates also change over time in response to factors like 10-year treasury yields and other economic conditions. The good news is, if mortgage rates drop after you borrow, you can explore options to lower rates like a cash out refinance.

Final Thoughts: Income and Mortgage Affordability

It's important to ensure that your mortgage is affordable. This may mean following one or more of the guidelines mentioned above or finding another way to determine what's affordable for you, like taking a close look at your budget. You should explore all of your options and work with a mortgage professional to get prequalified so you can get a better picture of what loan is right for you.