What Is The Percentage-Of-Income Rule For Mortgages?
Sarah Sharkey6-Minute Read
February 22, 2022
When you’re looking for a house, it is important to find one that meets your needs and budget. Luckily, you can determine how much home you can afford by using a simple rule of thumb to calculate the percentage of your income you should allocate to your mortgage each month.
So what percentage of income for mortgage should be set aside? Let’s find out!
What Is The Percentage Of Income Rule?
The traditional percentage of income rule of thumb says that no more than 28% of your gross income should go toward your monthly mortgage payment. When determining whether you qualify, most lenders consider percentage of income as well as a borrower’s debt-to-income ratio, which they prefer to be no higher than 36%. Combined, these are known as the 28/36 rule.
Sticking to this rule could be easier said than done depending on your income and your housing market. But keeping your budget at the forefront of your mind on your search as a home buyer can help you avoid a pinched budget later on.
The Metrics Of Mortgage Affordability
Here’s are two major metrics that lenders will take into account.
Rule Of 28
The Rule of 28, otherwise known as the percentage of income rule, advises not spending more than 28% of your gross monthly income on your mortgage payment.
You can find out where your income stacks up with the Rule of 28 by determining your gross monthly income. It’s essentially your total household income after taxes, obligated debt payments, and other essential expenses are taken out.
Let’s look at an example to see the Rule of 28 in practice. Suppose that your monthly income is $7,500. But you pay $1,000 in taxes and have a car payment of $500 per month. With that, your gross monthly income would be $6,000. Now, multiple your gross monthly income by 0.28 to determine how much you should spend on a mortgage each month.
In this example, you shouldn’t spend more than $1,680 on your monthly mortgage to stick with the percentage of income rule for mortgage.
Beyond the Rule of 28, your overall debt-to-income ratio (DTI) shouldn’t exceed 36%. The 36% should include your monthly mortgage payment. With that, your other monthly debt should fit in under the overarching cap of 36%.
Auto loans, minimum credit card payments, student loans, and more should all be considered when calculating your DTI. If you have substantial monthly payments eating away at your gross monthly income, you may not have as much to spend on a monthly mortgage payment.
If you don’t have any other debts, you may be able to stretch your home buying budget a bit further. The extra space in your monthly income could help you close on the home of your dreams.
How Much Mortgage Can You Qualify For?
At some point in the home buying process, you’ll need to apply with a lender to see how much mortgage you can qualify for. After running the numbers on your own DTI and monthly income, you might be surprised to find yourself qualified for a higher amount than you thought.
That’s because lenders will base your qualification on your income. Unfortunately, the lender likely won’t take your other expenses into account. And those other expenses make all the difference in a budget!
But remember, just because you qualify for an amount doesn’t mean you are obligated to spend that much on your home purchase.
How Much Mortgage Can You Afford?
Borrowers need to decide for themselves how much of a housing payment they can really afford. Although the Rule of 28 is a good place to start, developing a realistic future budget for your life as a homeowner is a smarter route.
As you build a future budget, start with your current monthly expenses. A realistic budget should include all of the modern necessities that you are unwilling to part with. For example, consider the costs of your cell phone and gym membership alongside your grocery and gas expenses.
In addition to your current expenses, add other costs specifically related to your new foray into real estate. A few commonly overlooked expenses include property taxes and routine home repairs.
If you take the time to map out a realistic budget ahead of time, that can help avoid the conundrum of being house poor. Essentially, house poor is a term for borrowers who can technically afford their mortgage payments, but the larger payment necessitates big cuts in other areas of their budget. For example, the borrower may have a beautiful home but not enough income to cover home repairs or new furnishings.
It is important to strike a balance between living in a beautiful home and having space in your budget to stop and smell the roses.
Check out our free home affordability calculator if you need help setting up a realistic budget. You’ll find a streamlined calculator to help you set a budget that works for your finances.
Strategies For Buying A House You Can Truly Afford
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.
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.
The Bottom Line: Relying Solely On Rules And Preapproval Amounts Can Make Homeownership Difficult
Preapproval amounts and the Rule of 28 can be a good way to see how big of a mortgage a lender may be willing to provide. But it is absolutely essential to run the numbers of a realistic budget before diving into homeownership.
Answer this question for yourself, “what price house can I afford?” Everyone has a different financial situation. So you’ll need to consider your budget carefully.
If you don’t run the numbers for yourself, you may end up buying more house than you can truly afford. Once you’ve finalized the home purchase, this issue could make homeownership difficult.
Before you begin your home search, start by determining how much you feel comfortable spending on a home. If you are ready to apply for a mortgage, begin the preapproval process online today.
Viewing 1 - 2 of 2
What Credit Score Do I Need To Buy A House?
When looking to buy your first house, it’s important to understand how your credit score can affect your mortgage eligibility. Check out our article to find out what credit score you need to a buy a house.