The 28/36 rule
A common rule of thumb is to keep your mortgage payment (including principal, interest, taxes, and insurance) at or below 28% of your gross monthly income. This is part of the 28/36 rule, which also suggests that your total debt payments, including your mortgage, should not exceed 36% of your gross income.
However, this can vary based on your personal financial situation, lifestyle, and goals. If you have little to no other debt, you may feel comfortable allocating more, whereas if you have other significant financial commitments, you might aim for a lower percentage.
To consider which percentage fits your needs, let’s take a step back to understand the different components of a mortgage.
What is a mortgage payment?
A mortgage is a type of home loan, and when you purchase a home with a mortgage, you will be expected to make monthly payments to pay back the loan, which includes the principal and interest – and in some cases, taxes and insurance.
Before committing to a mortgage payment, it is essential to consider all your current expenses and current total monthly debt, including credit card payments and student loan expenses. How much of your net income is currently dedicated to these expenses, and how much do you have left over once these expenses are accounted for?
That will help you determine a potential amount of money you could comfortably spend for your monthly mortgage payment. Identifying that number also makes it easier to evaluate home prices since you will roughly know what you can afford to pay per month.
How to calculate mortgage payments
Learn how to calculate your mortgage payment by examining the different elements involved.
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1
Mortgage principal
Mortgage principal refers to the amount of money borrowed when taking out a mortgage loan. The principal is the loan amount itself, without adding interest or other costs. The mortgage principal is the key figure to look at when deciding what percentage to allocate toward your mortgage since the principal will make up the bulk of the monthly payment.
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2
Mortgage interest
Mortgage interest is the amount borrowers pay to the mortgage lender in exchange for the home loan (the principal). Mortgage interest is paid monthly and calculated as a percentage of the total amount borrowed. It can also vary based on the amount of money borrowed and the length of the mortgage.
After the mortgage principal, the mortgage interest will be the next big chunk of the monthly payment, which is why factoring in interest rates to the total you will be paying each month is so important.
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3
Real estate taxes
Homeowners pay real estate taxes on the property they own. Real estate taxes are calculated based on the property’s value, but there may also be other state or federal tax implications to consider. Property taxes are often included within the mortgage payment, and part of the monthly payment will go toward paying taxes on the owned home.
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4
Private mortgage insurance (PMI)
The final component in a mortgage payment is insurance. Private mortgage insurance (PMI) may be required in some instances by mortgage lenders, e.g., when a lower down payment is made, and the loan amount itself is quite high.
How much should I spend on a house?
Now that we’ve looked at the different parts of a mortgage payment, the next big question is how much to spend on a home.
The amount you spend on a home largely depends on your financial circumstances, long-term financial goals, and current debt-to-income ratio. When looking at home prices, think about your mortgage-to-income ratio and what that could look like.
How much can you comfortably spend on a mortgage once you account for your current expenses and savings? What does your long-term income projection look like, and do you feel confident you can make the payments long-term? These are just some questions to consider, especially as you move forward in life and have other responsibilities and expenses come up.
What is your deb-to-income ratio (DTI)?
One of the main metrics that mortgage lenders will evaluate mortgage applications against is the debt-to-income ratio. Debt-to-income ratio is calculated by calculating how much money you owe through debt, such as credit cards and students, vs. how much money you make.
The DTI metric is a crucial part of the mortgage evaluation process as that is how mortgage lenders will decide whether you will be able to afford your payments and make them over time.
A high DTI signals to lenders that you have too much debt relative to your income, and that poses a risk when it comes to being able to make your monthly payments.
Different lenders will have varying criteria on what is considered a high or low DTI, so make sure to shop around when seeking a mortgage.
4 ways to lower mortgage payments
Other options are available if you have a high DTI score, or your current financial situation does not fit with the different percentage breakdowns described above. You can take some measures to lower your monthly mortgage payment and make it more affordable for you.
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Increasing your credit score is one way to reduce your monthly mortgage payment. Mortgage payments tend to be higher for those with low credit scores as a way for lenders to mitigate some of the borrowing risk. However, mortgage lenders are more likely to offer better loan terms with a higher credit score.
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Another option is to lengthen the mortgage loan term to reduce your monthly payment. Lowering a mortgage loan term can be a great option to reduce monthly payment amounts to something more manageable without making any dramatic changes. Lengthening your mortgage loan term may lead to paying more interest over time, but your monthly payments will remain more affordable comparatively.
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You can also reduce your monthly payments by putting down a larger down paymen. By putting down a larger down payment, you reduce the principal you borrow from a mortgage lender, which means your monthly payments will be lower overall.
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When looking at homes, it’s generally a good idea to look at houses at various purchase prices so you can determine the best option for you. If the higher price points mean you will have a higher monthly payment, it might be worth lowering your purchase price to find a home where the payments will be easier to make long-term.
