Buying a house with a mortgage is considered as one of the most extensive personal investments. There are quite a few types of costs that a person have to consider while applying for a mortgage. Moreover, you have to consider how much mortgage you could able to afford with your income. As a general rule of thumb, you should invest 28% or less of your gross monthly income towards the monthly mortgage payment.
What is a Monthly Mortgage Payment?
If you took a mortgage to finance your house then you will be very familiar with the term monthly mortgage payment. A mortgage payment is an amount that you pay to your lender every month. What will be your monthly mortgage payment depends on quite a few things like the principal, down payment, interest rate, loan term, etc. If your mortgage has a fixed interest rate then the monthly payment amount will also remain the same for the whole loan term. However, if the interest rate is not fixed then your monthly mortgage amount will fluctuate every month.
What Is Included In A Mortgage Payment?
Usually, a mortgage payment has four main components: principal, interest, taxes, and insurance. All these components made up the monthly mortgage payment. Having a clear idea of all these components will help you determine how much mortgage you can afford for your house.
It is the fundamental component of a mortgage payment. Principal refers to the loan amount that you have borrowed from the lender. You have to pay the principal amount that you have borrowed from the lender. For example, if you take a mortgage of $100,000 with a 4% interest rate and if you make a 20% down payment which is equivalent to $20,000 then your remaining principal will be $80,000. In the first year, most of your mortgage payment would be the interest rate while the payment in the last year mostly consists of the principal.
This is the profit and reward that the lender gets for taking the risk and lending you the money. This is a very important factor because the interest rate has a direct impact on how big your mortgage payment would be. Here, a higher interest rate means you have to pay a higher monthly payment. If you qualify for a higher interest rate then it means you can only borrow a small amount of money. On the other hand, if the interest rate is low then it means you can borrow more money without worrying about the monthly payment amount. For example, if you qualify for a $100,000 mortgage with a 6% interest rate and if the loan term is 30-year; then the monthly payment would be $599.55 ($500 interest + $99.55 principal.) However, if the interest rate is 9% then the monthly payment would be $804.62.!
You have to pay real estate or property taxes to the government. Usually, the government calculates the tax year based but you can make the payments monthly. Here, your property tax will be divided by the total number of monthly mortgage payments in a year. So, you can pay the property tax through your monthly mortgage payment, and then the lender will hold your tax amount until the taxes have to be paid.
If you have property insurance then you have to pay the insurance the same way you are paying the property taxes. Usually, you can pay two types of insurance through your mortgage payments, one is the property insurance and the other is the PMI. PMI is mandatory for people who have paid less than 20% down payment. Usually, this type of insurance protects the lenders if the borrower fails to repay the loan.
List of Suggested Income Ratio to Mortgage
There are several income ratios to mortgage available that help you determine how much of your salary you should spend on the mortgage payments. However, the actual amount depends on your financial condition, down payment, per month income, etc. Below I have elaborated on some common income ratios for a mortgage; let’s check them out!
The 28% Rule
According to this rule, you should not spend more than 28% of your monthly gross income on mortgage payments. So, let’s say you earn $20,000 per month. Now, according to this rule, you are allowed to spend $5600 or less as a monthly mortgage payment.
The 35% / 45% Model
According to the 35% / 45% model, your monthly mortgage payment should not exceed 35% of your pre-tax income or 45% of your after-tax income. In order to find out how much you can spend on a mortgage, you have to calculate your monthly income before tax and after-tax. Then you have to multiply your monthly gross income before tax by 0.35 and monthly gross income after tax by 0.45 to find out the exact amount. Now let’s say, your income is $12,000 before taxes and $10,000 after taxes. Then, according to the 35% / 45% model, you will be able to afford a mortgage payment of $4200 – $4500.
25% Post-tax Model
This income ratio to mortgage model suggests that you should spend 25% or less of your post-tax income on mortgage payments. For example, if your monthly post-tax income is $10,000 then you can spend $2,500 or less for the monthly payment. These modes will give you an idea about what amount is right for you to spend but the actual amount will depend on your financial conditions and goals.
FAQs about What is the Suggested Income Ratio to Mortgage
What’s the 50/30/20 budget rule?
According to the 50/30/20 budget rule, you should divide your after-tax income into three sections, where you can spend 50% on needs, 30% on wants, and 20% on savings.
What salary is needed for a 500K house?
If you want to afford a 500k house then your yearly income should be $113,000 per year. So, your monthly income should be around $9500 per month.
Should your mortgage be 1/3 of your income?
The answer to this question mostly depends on your financial condition. If you think you can spend 1/3 of your income on mortgage payments then you don’t have to worry about what the experts are saying. However, if you are struggling financially then you should try to keep the mortgage payments below 28% of your pretax monthly income. This way you will be able to keep the debt to income ratio low.
What is considered house poor?
If a person is spending more than 2/3 of his income on monthly mortgage payments, property taxes, maintenance, utilities, and insurance then he is considered as house poor.
Last Updated on August 7, 2022 by Ana S. Sutterfield
Magalie D. is a Diploma holder in Public Administration & Management from McGill University of Canada. She shares management tips here in MGTBlog when she has nothing to do and gets some free time after working in a multinational company at Toronto.