Mortgages can take as long as thirty years to pay off, and homes can cost hundreds of thousands of dollars. You may have a good sense of your budget at the grocery store or while shopping for clothes. But when the numbers get that big, it becomes much harder to set a realistic budget and find out how much you can afford. How can you calculate your mortgage budget when it’s so much larger and lasts so much longer than any purchase you’ve made before?
But there’s good news. SuperMoney has put together some rules of thumb to help you stay on track when shopping for a new home.
Rules of thumb
Unless you’re able to pay cash for your new home, you’ll have to get a mortgage. That means you need to consider two different types of costs: upfront and long term. Upfront costs include the down payment and closing costs. Long-term costs include the monthly payments you’ll make on your mortgage over the next several decades. To stay on budget, you’ll need to consider how much you can afford to lose today, as well as how much you can afford in the coming years.
There are several schools of thought when it comes to figuring out how much you can afford to spend on your mortgage. Generally, these rules are based on a percentage of your gross monthly income. Let’s dig into a few options.
A common rule of thumb for this is to keep your monthly mortgage payment under 25% to 30% of your gross monthly income.
Maximum mortgage payment
One popular way to determine your housing budget is to figure out the maximum mortgage payment you can afford. A common rule of thumb for this is to keep your monthly mortgage payment under 25% to 30% of your gross monthly income. So, if your household income is $120,000 per year, you should keep your monthly mortgage payment below $3,000 ($2,500 if you go with 25%).
Another popular rule of thumb is to keep your housing costs under 32%.
Maximum housing payment
Another popular rule of thumb takes into account your entire housing cost. In addition to your mortgage payments, this includes costs like property taxes and Housing Association (HOA) fees. According to this school of thought, you should keep your total yearly housing cost below about 32% of your annual income.
Maximum debt payment rule: “Keep the total amount of money you spend on debt payments under 40% of your income”
Maximum debt payment
The third rule of thumb takes into account your total monthly expenses for all your debts. That includes looking at your car loans, personal loans, and credit card debt. You should try to keep the total amount of money you spend on debt payments under 40% of your income.
What lenders look at
Lenders use more than just “rules of thumb” when evaluating your mortgage loan application.
First, mortgage lenders look at your credit score. Good credit indicates that you’ve been reliable and consistent in making loan payments, and gives you a better chance of qualifying for a large loan. Lenders also look at your income, as another indicator of your ability to make your payments on time.
Willingness to make a large down payment also impacts the lender’s decision. If you’re making a large down payment, the lender might offer to loan more money than if you had shown up with a very small down payment. This is because the ability to make a large down payment usually indicates you have substantial savings, which means less long-term risk to the lender.
Don’t always listen to your lender
But remember, you don’t have to listen to your lender. If you get approved for a $500,000 mortgage, you don’t have to spend the full $500,000. Lenders make money by charging you interest. That means that they have a vested interest in convincing you to take out a large loan.
Go into the lending process with an idea of how much you want to spend, and don’t let lenders pressure you to spend more just because you can.
Beyond the mortgage
It’s important to remember that the mortgage is just one portion of the cost of owning a home. You might have to pay Private Mortgage Insurance (PMI) or HOA fees. You’ll definitely need to pay property taxes, and every home requires maintenance. Make sure you leave room in your budget for those costs, even after accounting for mortgage payments.
The best rule of thumb to calculate how much you can afford will depend on your household’s circumstances. If you have a lot of other debts and monthly payments to make, consider the maximum debt payment approach. Or if your lender’s offer includes a lot of additional fees, such as private mortgage insurance, check out the maximum housing payment approach.
We’ve summed up the above rules of thumb in this chart. Take a look below to decide which option works best for you, and then use it to calculate your mortgage budget!
|Rule of thumb||How to calculate||Example (assuming annual income = $75,000)|
|Maximum mortgage payment||(Annual income / 12) * .28 >= monthly mortgage payment||($75,000 / 12) * .28 = maximum payment of $1,750|
|Maximum housing payment||(Annual income / 12) * .32 >= monthly mortgage payment + PMI + HOA fees + property taxes + maintenance||($75,000 / 12) * .32 = maximum monthly housing cost of $2,000|
|Maximum debt payment||(Annual income / 12) * .4 >= monthly mortgage payment + monthly car payment + monthly credit card payment + other monthly debt payments||($75,000 / 12) * .4 = maximum monthly debt payments of $2,500|
Ready to get started? Once you know your budget, your first step is to shop around for the right mortgage lender. Fortunately, SuperMoney has done the research for you! Click here to view a list of the top mortgage lenders on the market, plus user reviews and side-by-side comparisons.