Buying a home is one of the most important financial decisions many people will make in their lives. And it can also be one of the most complex. Even the simple question of what percentage of your income should be safely allocated to a mortgage doesn’t have a single clear answer that applies equally to all situations.
A financial advisor can help you find ways to help you reach your financial goals.
Mortgage payments and income
People and organizations that give home loans are naturally interested in lending money only to people who can afford to pay off the mortgage. To make this determination, they use a variety of methods, particularly debt-to-income ratios.
These parameters are well suited for creating mortgages that can be packaged and sold to investors. And borrowers should keep them in mind when applying for a loan. However, they are not always so helpful to someone who is primarily concerned with their personal financial well-being.
People deciding how much of their own income they can safely spend on a mortgage payment can take a variety of approaches to making this important decision. Here are some of the approaches that many have found useful.
Safe Mortgage Principles
There’s more than one way to calculate the safe percentage of your income you can plan to spend on your mortgage payment. Some approaches are suitable for certain circumstances, while others are better suited to different situations.
Assess your own position and, if possible, use more than one of the following techniques to determine how much of your income you can safely spend on paying for a house. Here are some of the options:
Debt ratio (DTI)
Your lender will usually calculate your debt-to-equity ratio (DTI) and look for a certain outcome to reassure themselves and the investors who will buy your mortgage that you can cover payments while staying current on car loans, student loans , credit cards and other debt payments.
After adding up all your monthly payments, including the mortgage, lenders generally want the total to be no more than 43% of your gross monthly income.
For example, let’s say you have a car payment of $500, you owe a minimum of $175 a month on your credit card, you owe $225 a month for a student loan, and you want to buy a house. with a mortgage payment of $2,000. You will typically need around $6,744 in gross monthly income to qualify for a loan from most lenders.
To figure this out, add up all your debt payments like this: $500 + $175 + $225 + $2,000 = $2,900.
Now divide that by 43: $2,900 / 43 = $6.74419. Multiply this result by 100 to get the monthly gross income required, $6,744.19, for a DTI of 43%.
The 30% rule
Another way to calculate how much of your income you can spend on a mortgage is to simply multiply your gross income by 30%. This will produce a number that you can hypothetically afford to pay for your mortgage each month.
For example, if you earn $5,000 per month, 30% of that amount is $1,500. The calculation looks like this $5,000 x 0.3 = $1,500.
This rule can also be stated as the 28% rule and calculated in the same way. It differs from the DTI because it does not specifically take into account other debt payments you may have.
Income divided by two and a half
You’ll get a slightly different number if you assume your mortgage payment can be two and a half times your gross income. To do this, start with your gross income and divide it by 2.5.
For example, if you earn $5,000 per month, the calculation would be $5,000 x 2.5 = $2,000. This suggests that $2,000 is a safe amount you can commit to your monthly mortgage payment.
This is clearly a more liberal method than the 30% principle and, like it, may not adequately account for other payments you need to make.
Limits of safe mortgage calculations
Every borrower and every mortgage is a little different. While these techniques for calculating what percentage of your income you should be spending on a monthly mortgage payment are useful heuristics, to generate a more reliable figure you’ll need to consider some other variables.
Other important factors include the amount of down payment you make, the amount of closing costs, the type of mortgage, the interest rate, your credit score, and other costs, including fees. association of owners or co-ownership, insurance against risks and property taxes.
It’s generally wise to keep in mind that the amount of money a lender will lend you may be more than you can safely borrow.
Conclusion
You can use more than one method to determine how much of your income you should spend on a mortgage. Lenders will often be happy with a certain debt-to-equity ratio, but that doesn’t mean you’ll be comfortable making the payment. As a general rule, it is advisable to use more than one approach to make this calculation and to strive to include as many aspects of your personal situation as possible.
Mortgage advice
You might want to consider talking to a financial advisor to make big decisions like buying a home. SmartAsset’s free tool connects you with up to three approved financial advisors in your area, and you can interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
After deciding how much of your income you can spend on a mortgage, it is necessary to determine the amount of the mortgage payment on a given property. You can do this using SmartAsset’s Mortgage Calculator.
Photo credit: ©iStock.com/Perawit Boonchu, ©iStock.com/ArLawKa AungTun, ©iStock.com/jhorrocks
The post What Percentage of Your Income Should Safely Go to a Mortgage? appeared first on SmartAsset Blog.
