What Should Your Mortgage Be Based On Your Monthly Income?

Unless you're lucky enough to hit the Powerball lottery or receive a large inheritance from a rich uncle, your salary is likely to be the biggest determining factor in how much house you can afford to purchase if borrowing money to do so. That relationship is typically expressed as what portion of your income should be earmarked for mortgage payments, which are defined by Chase Bank as "the amount you pay lenders for the loan on your home or property, including principal and interest." Sometimes — but not always — mortgage payments will also include ancillary costs to home ownership such as insurance and property taxes.

While every homebuyer's situation will vary in terms of other existing debts, expenses, and retirement goals, the general rule of thumb is that you should spend 28% or less of your monthly gross (pre-tax) income on mortgage payments. For a person earning $60,000 annually, that translates to $5,000 per month in gross income. $5,000 multiplied by 28% equals a maximum mortgage payment of $1,400 per month.

Granted, $1,400 per month isn't going to buy you much in today's red hot real estate market, but the good news is that the income of other members of the household who will be contributing to the mortgage payments should also be considered. So if you earn $60,000 annually and your spouse also earns $60,000 annually, now you've got a more realistic $2,800 per month to spend. 

There are other alternatives besides the 28% rule

Although the so-called 28% rule is a popular method to calculate affordability, it's definitely not the only game in town. There's also the 35%/45% model, in which your total monthly debt, including mortgage payment, shouldn't exceed 35% of your gross income or 45% of your net income, which is the income remaining after taxes and other contributions are withheld.

Depending on how high your other monthly debt obligations are, this method of calculation can be more generous than the 28% rule. For example, $5,000 per month gross income times 35% equals $1,750 per month. That's $350 per month higher than using the "28% rule" but other debt payments such as car payments, student loans, and credit cards must also be covered by the $1,750 per month.

While such guidelines are helpful in determining affordability and the price range of homes that you should be targeting, lenders have the ultimate say in the size of the loan that they're willing to approve you for. The industry term for the percentages that we've been discussing is your debt-to-income ratio or DTI. For conventional loans, such as those securitized by government agencies Fannie Mae and Freddie Mac, the preferred DTI is 36%, with a maximum in the 43% to 45% range. Insured loans from the Federal Housing Administration (FHA) may have some additional leeway, with up to a 50% DTI getting approved.

How much will that monthly payment buy?

Converting monthly payments into a target purchase price for a home depends on a few factors. Of course, the size of your down payment is going to affect your monthly payment, as will your credit score. Buyers with a strong credit score and history of using debt responsibly will generally be eligible for the lowest available interest rates.

At the time of this writing, the national average interest rate for a 30-year fixed mortgage is 8.01%. That equates to approximately $734 for every $100,000 financed. So buying a $500,000 home with a 20% down payment ($100,000) would result in $400,000 being financed with a payment of $2,936 per month excluding taxes, insurance, and closing costs at time of purchase.

Admittedly, mortgage rates are high right now relative to the recent past. That's because the Federal Reserve has been raising interest rates in a fight to bring inflation under control. To compare buying power to a time when mortgage rates were lower, every $100,000 financed at 6% costs $599.55 per month or $477.42 per month at 4% mortgage rates.