When you’re buying a home, it’s important to consider the breakdown of your monthly expenses alongside the overall cost. One of the largest and most significant expenses you’ll pay each month after purchasing a home is a mortgage.
Before you commit to your forever home or next investment property, you’ll likely find it helpful to know how much of your income you can expect to allocate to that monthly mortgage payment.
In this article, we’ll take a look at some of the general rules and formulas you can follow to calculate your mortgage-to-income ratio and determine how much home you can afford.
To determine how much income should be put toward a monthly mortgage payment, there are several rules and formulas you can use. The most popular is the 28% rule, which states that no more than 28% of your gross monthly income should be spent on housing costs.
Although most personal finance experts recommend the 28% rule, there are several other rules and guidelines that can be helpful in your calculations. Let’s take a look at a few.
The 28% / 36% rule is based on two calculations: a front-end and back-end ratio. As we’ve discussed, this rule states that no more than 28% of the borrower’s gross monthly income should be spent on housing costs – but it also states that no more than 36% should be spent on total debt costs.
To use this calculation to figure out how much you can afford to spend, multiply your gross monthly income by 0.28. For example, if your gross monthly income is $8,000, you should spend no more than $2,240 on a monthly mortgage payment.
The 35% / 45% rule emphasizes that the borrower’s total monthly debt shouldn’t exceed more than 35% of their pretax income and also shouldn’t exceed more than 45% of their post-tax income.
To use the first part of this rule, you’ll need to determine your gross monthly income before taxes and multiply it by 0.35. For the second part, multiply your monthly income after taxes by 0.45.
The 25% rule allows borrowers to use their net income in calculations, which may be easier for borrowers who are unsure about their gross monthly income. This rule states that no more than 25% of your post-tax income should go toward housing costs.
To follow this model, multiply your monthly income after taxes by 0.25.