What Percentage of Income Should Go to Your Mortgage?

Careful Cents Team

Careful Cents Team

August 26, 2020  •  5 min read

When figuring out how much house you can afford, there are many factors you need to account for, including your debt payments, your personal needs and all the other regular expenses you have each month. 

A good rule of thumb is to put no more than 30% of your income toward your mortgage. This general ratio is used widely by mortgage lenders, and is a good starting point when trying to estimate your monthly housing budget. 

What is the 30% Rule for Housing Costs?

When budgeting, it’s sometimes helpful to use ratios to figure out how much you should spend on different things. For example, the 50/30/20 ratio—created by U.S. Senator Elizabeth Warren—explains that you should allot 50% of your income for your needs, 30% for debt and savings, and 20% for the things you want. 

The 30% rule—which has been a common standard for decades and can work with the 50/30/20 ratio—is a similar budgeting calculation that recommends allotting 30% of your gross income for housing costs. This is so you don’t spend all your monthly income on housing, leaving you plenty of money (70% of your income) to cover your other needs and desires. 

In addition to being a good budget guide, some mortgage lenders use a similar range when evaluating borrowing capacity. Lenders want to see that you’re not overleveraged, and will look favorably on a borrower whose total housing costs don’t exceed 28% to 30% of their income. 

Keep in mind that these budget guidelines depend on your income, where you live and your unique life circumstance. If you live in New York City, you may find you need to shell out more than 30% of your income to cover the high cost of living. Similarly, if you live in a rural state, you may find your housing cost is substantially lower than one-third of your monthly paycheck.

Create a Monthly Budget to Know What You Can Afford

Some people may find if they allocate 30% of their income for their mortgage, they won’t have enough money left over to cover monthly expenses.That’s why creating an initial budget is so important. Once you calculate your expenses, you’ll know how much money you have to work with each month and can determine if the 30% rule is right for you. 

To create a budget, write down all your expenses and subtract them from your monthly income. This will give you an idea how much you can spend on housing after covering all your essential needs. Follow these three steps to create an initial budget: 

  1. Calculate all your expenses. Make a list of all the expenses you have each month. This could be things like credit card payments, insurance, transportation, subscriptions and anything else you pay for on a monthly basis.Try to also estimate the average  amount you spend on things like groceries, gas and eating out. Add all these costs together to find out how much you spend on essentials monthly.
  2. Plan for savings, emergencies and variable spending. Beyond covering your core expenses, try to put some money into savings every month—whether for an emergency, retirement or miscellaneous spending. A buffer of savings can be a lifesaver if anything unexpected happens. And it’s critical to have extra spending money in your budget to make sure you don’t overspend.
  3. Subtract your expenses from your after-tax monthly income. Take the total of your expenses and the amount you plan to save, and subtract these from your taxed monthly income. It’s important to subtract this from your taxed income so you can see the true amount you’ll have left over each month.

As long as you account for all the possible expenses you have in a month (including a buffer for savings and emergencies), the amount you have left over after this calculation can be used for your housing costs. Of course, you don’t have to spend the whole amount on housing, but with this budget calculation you’ll at least know the maximum you can afford. 

Calculate Your Debt-to-Income Ratio

When evaluating applicants, mortgage lenders use your debt-to-income ratio (DTI) to see how much you can afford.This calculation compares your total monthly debt burden with your gross monthly income, and is one metric lenders use to gauge your ability to make your monthly mortgage payment. 

To calculate your DTI, add up all your monthly debt payments—including personal loans, credit cards, student loans and mortgage—and divide this total by your gross monthly income. Remember, your gross income is how much you make before tax. 

For example, imagine you make $75,000 a year (that’s $6,250 gross per month). Then imagine your monthly debt payments ($150 for credit cards, $400 for student loans, $1,500 for mortgage, $300 for auto) total $2,350. When you divide your total debt burden ($2,350) by your gross monthly income ($6,250) you get a DTI of 38%. 

Borrowers with a high DTI are  considered more risky, as they have less money going into their pocket and may be more likely to struggle with their monthly payments. Generally, to get approved for a mortgage, lenders will look for a DTI under 43%. 

Make sure not to confuse your DTI with your other allocation ratios—like the 30% for housing. Though these ratios calculate similar things, your DTI factors in all your debt payments, giving lenders a more holistic view of exactly how much you can afford each month. In the example calculation above, the DTI was 38%, but the ratio of income going toward housing was roughly 24%. 

Ultimately, you could keep your housing costs under 30% of your income, but if you spend the other 70% making debt payments, your DTI would be too high for any lender to approve you for a mortgage. 

Our Two Cents

Using budgeting rules can be great for planning, but remember each lender has different requirements. If you’re thinking about getting a mortgage, shop around to see what’s available and speak to a few lenders to understand what they’re looking for. 

Similarly, every person is different, and the budgeting technique that works for other people, may not work for you. Be flexible when planning your budget. Just be sure you don’t overextend yourself with payments you can’t afford.