What Percentage Of Income Should Go To My Mortgage
February 28th, 2021 by Hernandez |Posted in Blog |
How much house can you really afford? With rising rent prices, this can be a little bit of a hot-button topic. Financial gurus and thrifty spenders weigh in with many different opinions. But what matters is what the bank is willing to lend you and what you can swing, not just on paper but in real life.When you own a home, your mortgage includes four different components. When you rent, your monthly payments go a bit further and take care of everything from lawn care to maintenance. Homeowners are shelling out extra for these costs, but at the same time, they are building equity in their property.
Save A Bigger Down Payment To Make Your Home More Affordable
Remember, your down payment amount makes a big impact on how much home you can afford. The more cash you put down, the less money youll need to finance. That means lower mortgage payments each month and a faster timeline to pay off your home loan! Just imagine a home with zero payments!
Now, were always going to tell you that the best way to buy a home is with 100% cash. But if saving up to pay in cash isnt reasonable for your timeline, youll probably wind up getting a mortgage.
If thats you, at the very least, save up a down payment thats 10% of the home price. But a better idea is to put down 20% or more. That way you wont have to pay private mortgage insurance .
PMI protects the mortgage company in case you dont make your payments and they have to take back the house . PMI is a yearly fee that usually costs 1% of the total loan value and isyou guessed ityet another expense thats added to your monthly payment.
Lets backtrack for a second: PMI may change how much house you thought you could afford, so be sure to include it in your calculations if your down payment will be less than 20%. Or you can adjust your home price range so you can put down at least 20% in cash.
Trust us. Its worth taking the extra time to save for a big down payment. Otherwise, youll be suffocating under a budget-crushing mortgage and paying thousands more in interest and fees.
How To Afford A Bigger Mortgage
You can afford a more expensive home by following three simple steps as you prepare to apply for a mortgage:
Of course, these steps may be easier said than done, especially for a firsttime home buyer.
How are you supposed to pay down debt and increase your savings at the same time? Often its a struggle to even meet monthly expenses.
But nearly everyone at least, nearly everyone with homeownership plans can find some economies in their household budgets. And its surprising how often just a small improvement in your DTI, down payment, or credit score can make a big difference to the mortgage deal youre offered.
So do what you can. But if your financial situation isnt perfect, dont let that stop you. Mortgage programs today are flexible, and you might be surprised at what it takes to qualify.
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Eliminate Private Mortgage Insurance
If your down payment is less than 20% , youll make extra payments to protect your lender. This is called private mortgage insurance . However, eliminating PMI reduces your mortgage payment.
Lenders typically allow you to request PMI cancellation when your principal loan balance reaches 80%. By law, your lender must remove it when your principal loan balance reaches 78% of the original value of your home.
Mortgage Credit Insurance Other Services
Mortgage credit insurance comes into play if you are faced with circumstances that prevent you from repaying your debt for instance, in the case of death, illness or job loss.
Lenders can require that you buy a mortgage credit policy.
They may propose a policy to you in a package with your mortgage credit agreement but this cannot be made a condition for you to obtain the mortgage credit.
You are always free to look for better conditions from other insurers, as long as the level of guarantee offered by different policies is equivalent to what is required by the lender.
Lenders can, however, oblige you to open a payment or savings account with them, from which you will repay the loan.
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What Is The 28/36 Rule
Lenders may determine your ability to afford a new home by using the 28/36 rule. Breaking it down, the rule establishes that:
Housing expenses should be no more than 28% of your total pre-tax income. This includes your monthly principal and mortgage interest rate, annual property taxes, and private mortgage insurance payments .
Total debt should not exceed 36% of your total pre-tax income. This includes the housing expenses mentioned above credit cards, car loans, personal loans, and student loans so long as these monthly debt payments are expected to continue for 10 months or more.
In concrete numbers, the 28/36 rule means that a borrower who makes $5,000 a month should not spend more than $1,400 on housing costs every month. If youre a renter, thats the most you should spend on your lease to maintain good financial health.
However, for a homeowner, $1,400 should cover your monthly mortgage payment, as well as homeowners insurance premiums and property taxes.
Why You Can Trust Bankrate
Founded in 1976, Bankrate has a long track record of helping people make smart financial choices. Weve maintained this reputation for over four decades by demystifying the financial decision-making process and giving people confidence in which actions to take next.
Bankrate follows a strict editorial policy, so you can trust that were putting your interests first. All of our content is authored by highly qualified professionals and edited by subject matter experts, who ensure everything we publish is objective, accurate and trustworthy.
Our mortgage reporters and editors focus on the points consumers care about most the latest rates, the best lenders, navigating the homebuying process, refinancing your mortgage and more so you can feel confident when you make decisions as a homebuyer and a homeowner.
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Interest Rates And Your Credit Score
While theres no specific formula, your credit score affects the interest rate you pay on your mortgage. In general, the higher your credit score, the lower your interest rate, and vice versa. This can have a huge impact on both your monthly payment and the amount of interest you pay over the life of the loan. Heres an example: Lets say you get a 30-year fixed-rate mortgage for $200,000. If you have a high FICO credit scorefor example, 760you might get an interest rate of 3.612%. At that rate, your monthly payment would be $910.64, and youd end up paying $127,830 in interest over the 30 years.
Take the same loan, but now you have a lower credit scoresay, 635. Your interest rate jumps to 5.201%, which might not sound like a big differenceuntil you crunch the numbers. Now, your monthly payment is $1,098.35 , and your total interest for the loan is $195,406, or $67,576 more than the loan with the higher credit score.
How Do Lenders Determine What I Can Afford
Lenders determine how much house you can afford by taking into account your gross income, debt to income ratio and credit score. Take a look at the guidelines you can consider below:
- Gross income: Your lender will need to know how much you earn. Youll need to provide current pay stubs, W2 forms or tax records, for example.
- Debt-to-income ratio: Your DTI ratio refers to your monthly debt payments divided by your monthly gross income. You can calculate it yourself by adding up your fixed monthly debt payments, such as rent, student loans, auto loans any payments that dont vary each month. Next, divide your monthly bills by your gross monthly income to arrive at your DTI ratio, also called your front end ratio. Its beneficial to keep your DTI ratio as low as possible when shopping for a mortgage. Lenders generally require a DTI ratio below 43%.
- Your credit score is a three-digit number that can range from 300 to 850 and is an indicator of how well you pay back debt. Various types of home loans require different credit scores. For example, if you get a conventional loan, which is a loan not backed by a government entity, you should have a credit score of at least 620. On the other hand, you will need at least a 500 credit score with a 10% down payment for an FHA loan, a loan backed by the Federal Housing Administration. Youll need a 580 credit score to qualify for a the 3.5% low down payment advantage.
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Lengthen Your Mortgage Term
Instead of choosing a shorter mortgage term, you might want to opt for a lengthened mortgage term. For example, you may consider choosing a 30-year fixed-rate mortgage instead of a 15-year fixed-rate mortgage.
Lets say you borrow $200,000 to buy a home with an interest rate of 4%. Your mortgage payment would be $955 per month over the course of 30 years .
Now, lets say you keep the same loan amount and interest rate and consider a 15-year mortgage instead. Youd pay $1,479 per month .
Lengthening your mortgage term can make a big difference in how much you pay per month, though keep in mind that youll also pay interest for a longer period of time.
The Mortgage You Can Afford Vs What You Qualify For
Though the above steps can give you a good idea of what you can afford, the number you come up with may not match what a mortgage lender deems you’re eligible for when you apply.
Mortgage lenders base your loan amount and monthly payment on several factors, including:
When you apply for a mortgage loan, your lender will give you a loan estimate that details your loan amount, interest rate, monthly payment and total loan costs. Loan offers can vary greatly from one lender to the next, so you’ll want quotes from a few different companies to ensure you get the best deal.
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Salary Is A Poor Indicator Of Mortgage Affordability
Lets suppose your salary is $100,000 a year. You could, by this rule of thumb, afford a mortgage of between $200,000 and $250,000.
But one person on that income may have much less left at the end of each month than another.
For example, lets assume that one is a real estate agent with a big auto loan and credit card balance from expensive lifestyle choices. Theres nothing wrong with any of that if he can afford it.
But another person with the same household income may have a much lower cost of living. Maybe hes a freelance graphic designer who drives a paid-off car. His wardrobe costs a few hundred a year to maintain and he zeroes his card balances every month.
These two people have significantly different available income to pay towards a mortgage. So pre-tax income on its own doesnt capture the whole picture.
Check Your Credit History
When you apply for a mortgage, lenders usually pull your credit reports from the three main reporting bureaus: Equifax, Experian and TransUnion. Your credit report is a summary of your credit history and includes your credit card accounts, loans, balances, and payment history, according to Consumer.gov.
In addition to checking that you pay your bills on time, lenders will analyze how much of your available credit you actively use, known as credit utilization. Maintaining a credit utilization rate at or below 30 percent boosts your credit score and demonstrates that you manage your debt wisely.
All of these items make up your FICO score, a credit score model used by lenders, ranging from 300 to 850. A score of 800 or higher is considered exceptional 740 to 799 is very good 670 to 739 is good 580 to 669 is fair and 579 or lower is poor, according to Experian, one of the three main credit reporting bureaus.
When you have good credit, you have access to more loan choices and lower interest rates. If you have poor credit, you will have fewer loan choices and higher interest rates. For example, a buyer who has a credit score of 680 might be charged a .25 percent higher interest rate for a mortgage than someone with a score of 780, says NerdWallet. While the difference may seem minute, on a $240,000 fixed-rate 30-year mortgage, that extra .25 percent adds up to an additional $12,240 in interest paid.
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What Percentage Of Your Income Should Go Towards Your Mortgage
Your salary makes up a big part in determining how much house you can afford. On one hand, you may want to see how much you could afford with your current salary. Or, you may want to figure out how much income you need to afford the house you really want. Either way, this guide will help you determine how much of your income you should put toward your mortgage payments every month.
Are You Ready To Buy A Home
Do you need help buying a home? Cadence Banks mortgage experts are happy to help. Contact us today to learn about our mortgages and the competitive rates we offer.
This article is provided as a free service to you and is for general informational purposes only. Cadence Bank makes no representations or warranties as to the accuracy, completeness or timeliness of the content in the article. The article is not intended to provide legal, accounting or tax advice and should not be relied upon for such purposes.
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Use Our Mortgage Calculator To Determine Your Home Budget
Sure, you could crunch the numbers yourself by dividing a home price by 180 months and then multiplying the decreasing monthly principal balance by your interest rate. But if you’re anything like us, you probably broke a sweat just reading that formula.
To save yourself the time and headache of doing a ton of math, we built a mortgage calculator to do that for youphew!
Sticking with our example of an income of $5,000 a month, you could afford these options on a 15-year fixed-rate mortgage at a 4% interest rate:
- $187,767 home with a 10% down payment
- $211,238 home with a 20% down payment
- $241,415 home with a 30% down payment
- $281,650 home with a 40% down payment
Remember: This is just a ballpark! Dont forget that grown-up stuff like property taxes and home insurance will top off your monthly payment with another few hundred dollars or so . And if you think youll be buying a home thats part of a homeowners association , youll need to factor those lovely fees in as well.
For example, if you plug in a mortgage amount of $211,238 with a 20% down payment at a 4% interest rate, youll find that your maximum monthly payment of $1,250 increases to $1,515 when you add in $194 for taxes and $71 for insurance. To get that number back down to a monthly housing budget of $1,250, youll need to lower the price of the house you can afford to $172,600.
What To Do Before You Buy
Whatever you can afford, you want to get the best mortgage ratesand you want to be in the best position to make an offer on your house. Make these steps part of your preparation:
- Check your credit score. Your can have a direct affect on the interest rate youll pay. Check your score, and do what you can to improve it. You can get a free credit report at AnnualCreditReport.com.
- Get pre-approved. Go to a lender and get pre-approved for a loan before you make an offer on a house. It will put you in a much stronger bargaining position.
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What To Do If You Want More Home Than You Can Afford
We all want more home than we can afford. The real question is, what are you willing to settle for? A good answer would be a home that you wont regret buying and one that wont have you wanting to upgrade in a few years. As much as mortgage brokers and real estate agents would love the extra commissions, getting a mortgage twice and moving twice will cost you a lot of time and money.
The National Association of Realtors found that these were the most common financial sacrifices homebuyers made to afford a home:
These are all solid choices, except for making only the minimum payments on your bills. Having less debt can improve your credit score and increase your monthly cash flow. Both of these will increase how much home you can afford. They will also decrease how much interest you pay on those debts.
Consider these additional suggestions for what to do if you want more home than you can afford:
- Pay down debt, especially high-interest credit card debt and any debt with fewer than 10 monthly payments remaining
- Work toward excellent credit
- Ask a relative for a gift toward your down payment, especially if you can demonstrate your own efforts toward becoming an excellent candidate for a mortgage
