How Much of Your Income Should Go to Your Mortgage?

A lot more goes into your mortgage than just the purchase price of your home.

When you’re deciding how much home you can comfortably afford, you have to take into consideration your current and future financial goals, as well as your potential interest, taxes and insurance.

What's in this article?

What does a mortgage payment include?
How to calculate how much income should go toward your mortgage
How do lenders determine what borrowers can afford?
How to make your mortgage more affordable
Apply today with Compass Mortgage

In this article, we will break down all the pieces of a mortgage payment, show you the most common mortgage payment models and explain the process lenders use for determining how much to lend to the borrower.

What does a mortgage payment include?

Your monthly mortgage payment can be broken down into five components:

  1. Principal: The amount borrowed
  2. Interest: The cost of borrowing the money
  3. Property taxes: Based on the value of the property and your location
  4. Homeowners insurance: Protects your property from damage caused by fires or natural disasters
  5. Mortgage insurance: Depends on loan type and down payment amount

Use Compass Mortgage’s payment calculator to estimate your monthly payments and to get an idea of how your down payment amount and interest rate impact your payments.

For example, if you’re purchasing a $300,000 home with a 7% interest rate and 10% down payment, with a term length of 30 years, here is the estimated breakdown for your $2,631.50 monthly payment:

  • Principal and interest: $1,757.50
  • Tax and insurance: $750
  • Private mortgage insurance (PMI): $124

Mortgage calculators can help you estimate how much home you can afford, but the most accurate way to determine these costs is to work closely with a trusted mortgage loan officer.

When you budget accordingly, no part of the mortgage process will be a mystery. 

After you apply for the mortgage, you’ll receive a breakdown of all the costs involved in your Loan Estimate and Closing Disclosure. This documentation allows you to see the breakdown of costs you can expect over the life of the loan. 

But how do borrowers determine what they can afford ahead of time so they can budget appropriately?

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How to calculate how much income should go toward your mortgage

Mortgage lenders often recommend different models to help the borrower determine how much home they can afford. These models consider your debt-to-income ratio (DTI), also known as the “back-end ratio,” and the mortgage-to-income ratio, sometimes called the “front-end ratio.”

Your front-end ratio considers how much of your gross income goes toward mortgage costs, while your back-end ratio considers how much of your gross income goes toward all debt payments.

Use the following common models to determine how much you could potentially afford to spend each month on your mortgage.

28%/36% model

The 28%/36% model means that no more than 28% of your gross income should go toward your monthly mortgage payment and that all of your monthly debts should stay below 36% of your income.

Your monthly gross income is the amount you make per month before any deductions such as taxes.

For example, if you make $8,000 per month, multiply $8,000 by 0.28 for a total of $2,240. Using this model, your mortgage payment should not exceed $2,240 per month.

If you multiply $8,000 by 0.36, you would discover that you should keep your total monthly debt payments below $2,880 — including your mortgage.

35%/45% model

The 35%/45% model states that your total monthly debts should not exceed 35% of your monthly gross income, and should not exceed 45% of your monthly net income, which is your income after taxes.

With this model, if your monthly gross income is $8,000 and you take home $6,000 per month post-deductions, here is your 35%/45% breakdown:

  • 8,000 x 0.35 = 2,800
  • 6,000 x 0.45 = 2,700

With this model, your monthly debts should not exceed $2,700-$2,800. 

25% model

The 25% model uses your net income and states that your monthly mortgage payment should not exceed 25% of your post-tax income.

If you take home $6,000 per month post-taxes, your monthly mortgage payment should not exceed $1,500 (6,000 x 0.25 = 1,500).

As you can see, this model gives you the least amount to spend on your monthly mortgage.

Ultimately, you should use the model that best fits your financial goals and takes your unique considerations into account.

How do lenders determine what borrowers can afford?

When you apply for a mortgage, your lender will ask for certain documentation to get a full picture of your financial situation.

Mortgage loan benchmarks include:

  • Credit score: A high score shows the lender you can responsibly manage your debt
  • Income: Proves how much you can afford based on your monthly income
  • DTI: Shows the lender how much of your income goes toward monthly debts
  • Down payment: A larger down payment lowers your mortgage payment

Sometimes, a borrower may need to wait to get a mortgage until they’re in a better financial situation. 

Even if your calculations indicate you can afford a mortgage, you may want to increase the space between what you can afford and what you really want to pay on a monthly basis for your home. 

That way, you can assess the potential to budget your income toward other debts or investments.

How to make your mortgage more affordable

Are you close to your dream of homeownership but want to increase the wiggle room in your budget?

Fortunately, there are factors that are within your control that can make your mortgage more affordable — even if it takes a few extra months before reapplying.

Here’s how to make the most of your financial situation:

  • Adjust your mortgage term: If you initially wanted to try to repay your loan more quickly with a shorter term, simply lengthen your term to a maximum of 30 years to lower your monthly payment
  • Boost your credit score: Work on making your monthly debt payments on time every month and paying down all debt to improve your score
  • Make a larger down payment: A larger down payment lowers your monthly payment, and putting down at least 20% eliminates the need to pay mortgage insurance on a conventional loan
  • Choose a more affordable home: Widen your search to a more affordable area or a smaller home to lower your payment
  • Choose the right loan type: Ask your lender if you’re eligible for any specific programs, or consider an FHA loan instead of a conventional loan if you need more flexibility with a lower credit score

Above all else, work closely with a mortgage loan officer you can trust to find the most affordable loan option for you.

Apply today with Compass Mortgage

Compass Mortgage treats our borrowers like family. We care about your financing needs and promise to be your partner and advocate throughout every step of the lending process.

To give our borrowers the ultimate competitive edge in a tough market, we offer a unique program called Get Committed®. This program provides a fully underwritten loan commitment and locks in your interest rate prior to finding the property you want to buy.

Standard pre-approvals do not guarantee that you will obtain a loan. By contrast, Get Committed® allows you to go through most of the steps in the loan process to secure a loan commitment even before you make an offer on a home.

A loan commitment essentially has the power of a cash offer, showing the seller you’re fully approved financially and that your deal isn’t likely to fall through.

Start here with your mortgage pre-approval. 

We can’t wait to work with you to find the most affordable loan for your home!

Photo by Mikhail Nilov