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Carrie Pallardy has more than nine years of experience writing about a range of topics, including healthcare and cybersecurity. Her expertise includes personal finance, insurance, real estate, and investing. She has a bachelor's degree from University of Illinois Chicago.
Published May 14, 2024 Fact checked by Fact checked by Betsy PetrickBetsy began her career in international finance and it has since grown into a comprehensive approach to journalism as she's been able to tap into that experience along with her time spent in academia and professional services.
If you are thinking of buying a home, you've probably heard the question "How much house can I afford?" The answer depends on your personal financial situation and your mortgage options.
What is the maximum percentage of your income that you should earmark for a monthly mortgage payment? This article looks at how mortgage payments are calculated and explains the common 28/36 rule that many lenders use to determine how much you can afford to pay. The 28 and 36 specifically refer to the fact that lenders recommend that you not devote more than 28% of your gross yearly income toward a mortgage or more than 36% of your gross income to all debts, including a mortgage.
Mortgage payments often consist of four main components:
You'll want to consider how all of these costs add up when you consider mortgage affordability.
The 28/36 rule is a common approach used to help determine how much debt an individual or household can safely assume. According to the second part of the rule, you should spend a maximum of 36% of your monthly income on debt payments, including your mortgage.
Many lenders will use the 28/36 rule when considering your application for a mortgage.
A number of factors come into play in determining how much you can afford when it comes to a mortgage.
Your income is a crucial factor mortgage lenders consider. Do you earn enough money to repay what you borrow?
Mortgage lenders also want to ascertain your income stability. Will you continue to earn enough to repay your loan? Lenders may be looking for a two-year history of consistent income to determine that your income is stable.
Your debt-to-income (DTI) ratio is another important indicator of your financial health. DTI is the percentage of your gross monthly income that you use to pay back debt, including your mortgage and other debt, such as credit cards, auto loans, and student loans.
Lenders typically want to see a DTI of 36% or lower (remember the 28/36 rule), but some will consider a DTI of 43% or even higher.
Your mortgage's interest rate has a significant influence on your monthly payments. Interest rates fluctuate as economic conditions change. The average 30-year fixed mortgage interest rate was 7.49% as of April 25, 2024, according to Investopedia's calculations. Individual factors, such as your credit score, will also affect the interest rate you may be offered.
Some mortgages have fixed interest rates that never change while other have adjustable rates than can go up or down over time.
A home is a large purchase. Buyers typically pay an upfront sum, the down payment, and take out a mortgage to finance the rest. Your down payment is calculated as a percentage of the total home cost. While a 20% down payment was once standard, the average down payment for first-time homebuyers was 6% in 2022.
A lower down payment can make homeownership more accessible, but there are benefits to larger down payments. For example, a bigger down payment can result in lower borrowing costs over time.
What is your mortgage affordability? Consider your:
If your housing and debt payments would exceed the 28/36 guideline, lenders may be less likely to offer you a mortgage or more likely to charge higher interest rates if they do.
While your mortgage payment will be a considerable line item in your budget, it is not the only cost that comes with homeownership. You'll also want to make sure you can afford items like these:
A home is an investment and one that requires maintenance. Smaller, routine maintenance, as well as big unexpected repairs, will be your responsibility. Setting aside 1% to 4% of your home's value each year can help create a fund for maintenance.
Monthly mortgage payments often include property taxes and homeowners insurance. But if your lender does not put funds for taxes and insurance into escrow, you will need to budget for those expenses in addition to your mortgage payment.
Homeownership is a major milestone that many people aspire to reach, but it probably isn't your only financial goal. How will your mortgage payment affect your lifestyle and financial goals? For example, will your mortgage payment prevent you from traveling as often as you would like?
There are many tools available to help you determine your mortgage affordability.
With the Investopedia mortgage calculator, for example, you can input your home price, down payment, loan term, and interest rate or credit score. The result will give you an idea of what your monthly payment, including principal and interest, property taxes, and homeowners insurance, could look like.
Other helpful resources include:
Your mortgage payment is a big expense, but some prospective homeowners forget to take the cost of home maintenance into consideration.
Neglecting to shop around for mortgage rates is another common mistake. Comparing different offers can help you get the best rate, cutting your monthly payments and saving you money in the long run.
Mortgage interest rates can be fixed or adjustable. With a fixed-rate mortgage, your interest rate will stay the same for the entire life of the loan.
With an adjustable-rate mortgage (ARM), however, your interest rate is variable. It can go up or down depending on current market trends. If your interest rate goes up, your monthly mortgage payments will also increase.
While lenders often use the 28/36 rule to guide their lending decisions, it isn't necessarily set in stone. Some may have higher or lower percentage rules. If you have a high credit score, lenders may be more willing to offer you a mortgage when you have a higher DTI.
If you expect your income to decrease or your expenses to increase, consider whether your mortgage will still be affordable under those conditions. You may need to look for ways to boost your income or cut your expenses. Or you may want to borrow less at the outset.
Refinancing your mortgage can potentially result in a lower interest rate and lower monthly payment.
Buying a home is a big decision. Your personal financial situation and the general economic conditions at the time will determine your mortgage affordability. Carefully consider both your mortgage payment and all the other costs of homeownership in relation to your income. Talking to a financial advisor about your budget and long-term financial goals can also help you navigate the home buying and borrowing process.
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A purchase-money mortgage is a mortgage issued to the borrower by the seller of the home as part of the purchase transaction.
A principal reduction is a decrease in the principal owed on a loan, typically a mortgage, as an alternative to foreclosure on the home.
An offset mortgage allows money in savings accounts held at the same financial institution as the mortgage to offset the mortgage balance.
A reverse mortgage initial principal limit is the amount of money a reverse mortgage borrower can receive from the loan.
A defeasance clause is a mortgage provision indicating that the borrower will receive title to the property once all mortgage payment terms are met.
A judicial foreclosure is a legal proceeding that allows lenders to obtain a power of sale through the courts when a borrower defaults on their mortgage.
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