What Percentage Of Your Income Should Be Your Mortgage?
Buying a home is typically the largest purchase a consumer will make in their lifetime. Committing to a mortgage is often a long term agreement. It is important that prospective homebuyers take time to carefully establish how much house they can afford and what percentage of income should go towards their monthly mortgage payment. To determine how much money should be allocated to a monthly mortgage payment, it is imperative for potential homebuyers to have a full understanding of the process, and identify what percentage of income a mortgage payment should be in order to comfortably and confidently afford monthly payments.
Understanding this percentage can help hopeful homebuyers achieve their personal and financial goals with less stress throughout the process. Knowledge about the relationship between debt and income can help homebuyers fully understand and identify the right types of mortgage products and corresponding payment options based on what will best fit their lifestyle. This will also help them determine how much of a mortgage payment is reasonable for their current financial situation.
Factors That Determine How Much House I Can Afford
To determine how much house a homebuyer can afford, an individual should multiply their annual salary by three at minimum and four at maximum to come up with the potential price range for a house.
This estimated price is just one consideration in determining how much house is affordable. Some key factors in calculating affordability are:
- Income: Income is any money a homebuyer receives on a regular basis, such as salary from any form of employment or funds from investments. Income helps establish a baseline for what is affordable.
- Debt-To-Income Ratio: Debt-to-Income Ratio (DTI) is a calculation to determine a monthly mortgage payment. It is confirmed by evaluating a potential homebuyer’s gross income (income before taxes) compared to their total potential and current debt. Lenders often recommend that a monthly mortgage payment should not represent more than 28% of an individual’s gross income.
- Available Funds: This is the amount of cash or liquid assets a potential homebuyer has available to use as a down payment and to cover closing costs for the home. Typically, the more money a homebuyer has to put down as a down payment, the lower the overall loan will be.
- A conventional loan down payment is usually 20% of the cost of the home, but it is possible to get a loan with less than 20% down. There are some mortgage programs that allows prospective buyers to get a loan with as little as 3% down. Because these programs can be of higher risk to the lender, many loans that allow a lower down payment threshold require with private mortgage insurance (PMI) in addition to the monthly mortgage payment. PMI is an additional monthly cost that needs to be factored in each month.
- Credit Score: A credit score is a number between 350 and 850 the represents five factors and usually helps lender evaluate credit-worthiness and low applicant eligibility. An individual’s credit score can be used to determines how much a potential buyer can borrow for a loan or their mortgage interest rate.
Determining Your Debt-To-Income Ratio
Calculating a mortgage payment, and determining what percentage of your income your mortgage should be is a calculation called debt-to-income ratio (DTI). It is important for a potential homebuyer to have an estimate of these figures and learn their (DTI) to determine how much house is affordable for them.
Debt-to-income ratio is determined by looking at a homebuyer’s gross income (income before taxes) to determine how much of a loan they can afford. An average of two years of income is typically used for calculations. This is known as front end DTI.
Once the average income is determined, a mortgage lender will confirm the DTI and recommend an eligible monthly mortgage payment. A lender suggests to not have more than 28% of person’s gross income (pre-tax) go towards a mortgage.
The amount a homeowner pays for their home monthly includes more than just the mortgage payment. Every month a homeowner will often be responsible for the loan’s principal and interest payment, real estate taxes, and homeowner’s insurance.
Once a potential home buyer determines how much they can afford to spend on a mortgage payment each month, the amount of other debts need to be taken into consideration. The other debts are other monthly bills such as credit cards, car payments and student loans. This is known as back end DTI. Lenders recommend that a homeowner should not spend more than 36% of their income on debt related costs.
Determining A Mortgage Payment
Buying a home is a big decision and there are many things to consider when evaluating a monthly mortgage payment. Once a potential home buyer has taken the time to examine their personal finances and established how much house they can afford by using the 28%/36% ratio that lenders recommend, it will easier to determine what a monthly mortgage payment will be.
Mutual of Omaha Mortgage offers a mortgage calculator to assist home buyers with an in depth and easy way to help calculate a mortgage payment.
Being prepared and having an understanding of what percentage of monthly income a monthly payment should be will help a potential homebuyer be more comfortable through the process and enjoy homeownership.