What Percentage of Income Should Go to Mortgage?

Before shopping for a new home, you’ll need to figure out how much house you can afford. Mortgage lenders will evaluate your income, debt load and credit score to come up with a figure. But prior to applying for a mortgage, there are several models you can use to determine the maximum amount of your monthly earnings that should go towards housing costs, even if it’s lower than what the lender offers.

How Mortgage Payments Work

When you take out a home loan, you make monthly mortgage payments to the lender over a set period until the balance is paid in full. All mortgage payments include principal and interest. Some also include homeowners insurance and property taxes if you opt to escrow these expenses or roll them into the monthly mortgage payment. 

A fixed-rate mortgage comes with the same principal and interest payment over the life of the loan. The longer the loan term, the more affordable your monthly payments will be. It also means your borrowing costs will be higher since the mortgage lender has more time to collect interest from you. 

That said, a shorter loan term yields a more costly monthly payment. You’ll pay the loan off sooner, though, and save a bundle in interest—furthermore, mortgages with more brief repayment periods are often common with more competitive interest rates. 

To illustrate, a $356,000, 30-year fixed-rate loan with an interest rate of 6.5 percent will cost you $2,250 per month, and you’ll pay $454,179 in interest over the life of the loan. So, the loan will cost you a total of $810,179. 

However, a 20-year fixed-rate loan for the same amount but a 5.5 percent interest rate comes with a slightly higher monthly payment of $2,448. As a result, the total interest cost drops to $231,903, bringing the total amount you’ll pay over the life of the loan to $587,903. That’s a difference of $222,276 simply by paying a few hundred dollars more per month and shaving 10 years off the loan term. 

But if you get an adjustable-rate mortgage, the interest rate will remain the same for a specified period and fluctuate for the remaining loan term. Consequently, your monthly mortgage payment will follow suit, making it challenging to budget since the interest rate will depend on market conditions. Common ARM mortgage products include:

• 5/1 ARM: comes with a fixed interest rate for five years, followed by a floating interest rate for the remaining loan term
• 7/1 ARM: get a set rate for seven years and a floating rate until the loan is paid in full
• 10/1 ARM: the interest rate is fixed for 10 years, and it floats for the duration of the loan

You should also know that the rate you’ll get during the fixed interest period is typically lower than you’ll get with a traditional fixed-rate home loan product to make the ARM more attractive. 

What Percentage of Income Should Go to Mortgage?

There are four common models prospective homebuyers use to calculate the percentage of income they should spend on a monthly mortgage payment. 

The 28% Rule

As the name suggests, this rule states that no more than 28 percent of your gross income should go toward your monthly mortgage payment. So, if your gross monthly income is $8,000, your monthly mortgage payment should not exceed $2,240. This calculation is often referred to as the front-end ratio. 

The 28/36 Model

The 28/36 model suggests that no more than 28 percent of your income be allocated to your mortgage payment and 36 percent to all other household debt, including credit cards, student loans, auto loans and personal loans. So, for example, if you earn $10,000 each month before taxes, your mortgage payment should be capped at $2,800 to avoid being house-poor, and household debt shouldn’t be more than $3,600.

The 35/45 Model

This model states that your total monthly debt obligations and mortgage payments should not exceed 35 percent of your pre-tax income (or gross earnings) or 45 percent of your post-tax income. To illustrate, if your monthly gross earnings are $9,500 and net earnings are $8,000, your monthly mortgage payment should be between $3,325 ($9,500 * .35) and $3,600 ($8,000 * .45).

The 25% Post-tax Model

You’ll want to keep your monthly mortgage payments below 25 percent of your net earnings per this more conservative model. So, if you’re compensated $7,800 after taxes, your monthly mortgage payment should be no more than $1,950 ($7,800 * .25).

What Factors Affect Your Mortgage Payments?

The following components make up your monthly mortgage payment: 

• Principal: the total amount you borrow 
• Interest: the price you pay the lender for the loan
• Taxes: property taxes assessed at the local level 
• Homeowners insurance: premiums to a coverage homeowners policy that protect your property if it’s damaged or destroyed
• Mortgage insurance: required if you put less than 20 percent down
• Association fees: homeowners association (HOA) and community development district (CDD) fees (if applicable)

How to Know How Much Mortgage You Can Afford

You’ll often find that prospective buyers use affordability calculators to determine how much they should spend on a home. But before doing so, consider these factors to come up with a practical figure: 

• Monthly income: What are your gross and net earnings each month? 
• Current debt load: How much are you spending each month on minimum monthly debt obligations? What is your debt-to-income ratio (DTI)? 
• Credit score: Is your credit score high enough to get you a competitive rate, or is it on the lower end? 
• Desired down payment: Can you afford to make the required down payment on the loan amount you’re considering? 

How to Lower Your Monthly Mortgage Payments

There are ways to lower your monthly mortgage payment if they aren’t quite working for your budget: 

Choose a Less Expensive House

Even if the lender pre-approves you for a sizable home loan, it’s up to you to decide how much of that amount you want to spend. It could be tempting to spend the maximum amount you’re allowed to get the more luxurious home, but a less expensive option could be ideal for your spending plan. 

Improve Your Credit Score

You’ll improve your chances of qualifying for a lower interest rate by boosting your credit score. A higher credit score shows the lender that you responsibly manage your debt obligation. It also means that the likelihood of defaulting on your monthly mortgage payments is low. In addition, you can improve your credit score by paying your bills on time, lowering the balances on revolving credit and refraining from opening new accounts that result in hard inquiries and decrease your credit age. It’s equally important to dispute any errors on your report that could be dragging your credit score down. 

To demonstrate how your credit rating impacts the rate you receive, here are the average annual percentage rates (APRs) and monthly payment amounts (principal and interest only) for a home price of $325,000 and a 30-year fixed-rate mortgage: 

• 620 to 639 FICO score: 7.754 percent interest rate and a $2,329 monthly payment
• 640 to 659 FICO score: 7.208 percent interest rate and a $2,208 monthly payment
• 660 to 679 FICO score: 6.778 percent interest rate and a $2,114 monthly payment
• 680 to 699 FICO score: 6.564 percent interest rate and a $2,068 monthly payment
• 700 to 759 FICO score: 6.387 percent interest rate and a $2,030 monthly payment
• 760 to 850 FICO score: 6.165 percent interest rate and a $1,983 monthly payment

If you select a 15-year fixed loan for the same amount, the average APRs are as follows: 

• 620 to 639 FICO score: 7.020 percent interest rate and a $2,925 monthly payment
• 640 to 659 FICO score: 6.474 percent interest rate and a $2,826 monthly payment
• 660 to 679 FICO score: 6.044 percent interest rate and a $2,750 monthly payment
• 680 to 699 FICO score: 5.830 percent interest rate and a $2,713 monthly payment
• 700 to 759 FICO score: 5.653 percent interest rate and a $2,682 monthly payment
• 760 to 850 FICO score: 5.431 percent interest rate and a $2,644 monthly payment

And here’s what you can expect if you go with a 7/1 ARM: 

• 620 to 639 FICO score: 5.253 percent interest rate and a $1,795 monthly payment
• 640 to 659 FICO score: 4.707 percent interest rate and a $1,687 monthly payment
• 660 to 679 FICO score: 4.277 percent interest rate and a $1,604 monthly payment
• 680 to 699 FICO score: 4.063 percent interest rate and a $1,563 monthly payment
• 700 to 759 FICO score: 3.886 percent interest rate and a $1,530 monthly payment
• 760 to 850 FICO score: 3.665 percent interest rate and a $1,489 monthly payment

*Source: myFICO as of 1/4/2023

Get a Longer Mortgage Term

A longer mortgage term will give you a more affordable monthly payment. But there are a few downsides to consider. You could get a higher interest rate than you would if you opted for a shorter term. Furthermore, the lender will have more time to collect interest from you, which increases your total borrowing costs over time. 

Make a Bigger Down Payment

Consider making a larger down payment to reduce the amount you need to borrow, lowering the monthly mortgage payment. For example, if you take out a 30-year $425,000 loan with a 7 percent interest rate and put down 5 percent, you’ll get a $2,686 monthly payment (principal and interest only). But if you increase the down payment to 20 percent, the monthly payment will drop to $2,262. 

Eliminate Your PMI

If you put down 20 percent or more, you will also avoid having to fork over costly private mortgage insurance (PMI) premium payments. 

Request a Tax Reassessment

Once you’ve purchased your home, contact the State Board of Equalization along with the property tax assessor in your county to arrange a hearing. They will analyze your property to determine if the among you’re being assessed in property taxes is accurate or should be decreased. If the latter applies, you’ll see a drop in your monthly mortgage payments. 

Refinance Your Mortgage

Have interest rates dropped since you took out your current mortgage? Assuming your credit score is at the same level or better than it was when you initially applied, consider refinancing to secure a better rate.

You can start the process with a reputable online lender, like Zero Mortgage, that takes the guesswork out of navigating the refinancing process from start to finish. Then, in less than 15 minutes, you can get a rate quote to decide if swapping out your current mortgage with a new one makes financial sense. Plus, you’ll receive guidance from an experienced member of the Zero Mortgage team to help you make an informed decision. Best of all, you won’t pay application fees, processing fees, underwriting fees or lender fees – it’s the Zero Mortgage difference that sets them apart from others in the industry. 

Explore your options by visiting the website and applying today.