Budgeting for a home is just as much about the mortgage payment as the purchase price. Mortgage payments typically include four expenses:[1]
- Principal: the original amount financed
- Interest: the cost of borrowing money as displayed as a percentage
- Taxes: your estimated annual property taxes, divided into even monthly amounts
- Insurance: your homeowner’s insurance premiums, divided into even monthly amounts; you may also have additional insurance premiums, depending on your loan terms (for example, mortgage insurance premiums (PMI).
If you can’t comfortably afford these payments with your income, you can create financial stress by stretching your budget too far.
That said, many homebuyers are unsure about how much income it takes to comfortably accommodate the mortgage payment. You know you need to have enough left over after paying the mortgage to cover other living expenses, savings and discretionary purchases. So it makes sense to base your mortgage budget on your individual income levels, designating a percentage of your income to the mortgage payment. This is called the mortgage-to-income ratio.
While you can use PNC’s mortgage affordability calculator to help estimate how much house you can afford, we also want you to understand how the affordability calculator works. So, in this article, you’ll learn how to calculate your mortgage-to-income ratio to determine how much of your income should go toward your mortgage payment.
Common Methods to Calculate Your Mortgage-to-Income Ratio
No hard and fast rule dictates how much of your income should go to a mortgage; however, lenders have guidelines on what they would approve. Some homeowners are more conservative, preferring to keep their mortgage payment to a smaller percentage, and some are more comfortable allocating more of their income to their home mortgage. So instead of one method to calculate your mortgage-to-income ratio, here are three models for you to choose from.
1. The 28% Rule
The 28% rule says you should keep your mortgage payment under 28% of your gross income (that’s your income before taxes are taken out).[2]
For example, if you earn $7,000 per month before taxes, you could multiply $7,000 by .28 to find that you should keep your mortgage payment under $1,960, according to this rule. You could take this a step further with the 28/36 rule, which says that, in addition to keeping your mortgage under 28% of your gross income, you should keep all your debts under 36% of your income. Your other debts would include any student loans, car payments, credit cards and utilities due.
For example, with a gross income of $7,000 per month, you would want to keep all your monthly debt payments, including the mortgage, under $2,520 ($7,000 x .36 = $2,520) if you’re following this model.
2. The 35/45 Model
The 35/45 model says that all your debts combined should be kept under 35% of your gross income and under 45% of your net income (which is your after-tax income).[3]
For example, if you earn $7,000 per month before taxes and your take-home pay is $6,000, your calculations would be as follows:
$7,000 x .35 = $2,450
$6,000 x .45 = $2,700
So, using the lesser of these two figures, you would want to keep your debt payments under $2,450 per month with the 35/45 model.
3. The 25% Post-Tax Model
The 25% post-tax model says that your mortgage payment should be less than 25% of your net income.[4]
For example, if you make $6,000 after taxes, you would want to keep your mortgage payment below $1,500 following the 25% post-tax model. This model is the most conservative of the three models, keeping your mortgage-to-income ratio comparatively low.
How Do Mortgage Lenders Determine How Much You Can Afford?
Each mortgage lender can set its own qualification requirements for a loan within legal boundaries, so there is not one universal rule for how mortgage lenders determine how much you can afford.[5] There are, however, three common criteria that lenders use to determine how much they are willing to loan on a home purchase.
1. Gross Income
Lenders use a mortgage-to-income ratio to confirm that you make enough money to comfortably afford the mortgage payments on your new home. According to the FDIC, most lenders have a maximum allowable ratio of 25-28% of your gross income going toward your mortgage payment.[6] However, in practice, many lenders are willing to go up to 36%, with some lenders willing to go higher in certain cases.
2. Debt to Income Ratio
Since many homebuyers carry additional debt (including student loans, credit cards, auto loans or medical debt), lenders want to confirm that your income is enough to cover all debts, including your new home loan, as well as living expenses. This is done by calculating a debt-to-income ratio (DTI). DTI is calculated the same way as the mortgage-to-income ratio, but instead of using only the mortgage expense, DTI uses the total sum of all monthly debt payments (as we saw in the “36” part of the 28/36 rule). According to the FDIC, most lenders look for a maximum DTI in the 33-36% range of your net income.[7]
3. Credit Score
Finally, lenders look at your credit score to determine how reliably you have used credit in the past. Most lenders look for a credit score of at least 620 for most loan types, although some loan types (like FHA loans) have lower credit score requirements.[8]
Ways To Keep Your Mortgage Payments Manageable
You can do a few things to keep your mortgage-to-income ratio at an acceptable range based on any of the methods mentioned in this article.
- Choose a house with a lower purchase price. This reduces the amount you need to borrow, which reduces your mortgage payments. We can help search for homes within your budget using our Home Insights Planner tool.
- Make a higher down payment. This allows you to borrow less, reducing your mortgage payments.
- Choose the right home loan type from the right lender to reduce your interest expense and your overall mortgage payment.
- Have a professional estimate your property taxes before committing to a home. And get homeowner’s insurance quotes from multiple providers.
- Review your property taxes and homeowners insurance premiums annually. Correcting inaccurate tax assessments or switching insurance providers could potentially reduce your mortgage payments.
- Ask for a raise or add a side hustle. Anything you can do to increase your income gives you more money that you could potentially allocate to your home.
The Bottom Line on Mortgage-to-Income Ratios
There is more than one way to determine how much of your income should go toward your mortgage payment. The important thing is to make sure that you qualify for a home loan and that your income is enough to comfortably accommodate the monthly mortgage payments for that loan.
