Consider the potential monthly payment amount rather than the overall amount of money you may borrow for a property. This will give you a better idea of whether or not you will be able to afford the mortgage. Because this is what you will be required to pay monthly, you will want to ensure that it is affordable within your financial plan. Generally, it is determined by dividing the total amount you pay toward your debts by your annual income. To be more exact, there are two methods that it may be measured:
- You are in luck since there are a few different rules of thumb that you can apply to answer the question, "how much should I pay on a mortgage?" We will go through them in great depth and help you determine which one is likely to be most beneficial to you, given the circumstances.
Front-end DTI ratio:
This considers your gross monthly income and compares it to your monthly mortgage payment as a percentage. For instance, if your monthly wage is $4,500 and your mortgage payment is $1,000, your front-end debt-to-income ratio would be 22% ($1,000 divided by $4,500). This would indicate that you have a moderate level of debt.
Back-end DTI ratio:
This considers all your monthly debt obligations, such as your mortgage payment, and calculates the entire amount as a percentage of your gross monthly income. For example, if you additionally pay $250 per month for student loans and $200 per month for your credit cards.
Rules of Thumb for How Much To Spend on a Mortgage
The DTI ratio may determine how much money should be spent on a mortgage payment. For instance, there are maximum limitations in place; nonetheless, it is sometimes a wiser idea to err on the side of conservatism so that you do not end up home poor, which means that your mortgage payments.
The 28/36 Rule
Your back-end DTI ratio shouldn't be any higher than 36 per cent. To put this another way, the amount you pay toward your mortgage shouldn't constitute more than 28% of your income before taxes, and the total amount you pay toward your mortgage plus all of your other debts shouldn't constitute more than 36% of your income before taxes.
Suppose you have a lot of unknowns in your life, such as a variable income, possible large bills on the horizon, or question marks around student debt forgiveness. In that case, it could be preferable to go for a more cautious rule of thumb than to guess how much money you will need. This way, you won't be locking yourself into a large monthly mortgage payment that you could find challenging to make in the future even though you can afford it now.
25% Post-Tax Model
To err on the side of caution, you should restrict your monthly mortgage payment to no more than 25 per cent of your income after taxes (i.e., what you see in your bank account). Take, for instance, a salary of $54,000; assuming taxes and other deductions, you would end up with a net take-home pay of around $2,900 each month. If you restricted your monthly mortgage payment to no more than 25% of your gross earnings, this would result in a mortgage payment of $729 per month. That is a significant reduction compared to the maximum mortgage payment of $1,000 you would be restricted to paying under the 28/36 regulation.
50% DTI Loans
In very unusual circumstances, you may be able to qualify for a conventional mortgage even if your back-end debt-to-income ratio is as high as 50%. This is permissible, for instance, for some kinds of loans underwritten by specialised software and offered via Fannie Mae. However, the fact that you may go up to a DTI of 50% does not always mean that you should. For instance, if you have an annual salary of $54,000, that translates into a mortgage payment of up to $2,250 per month, even if you may only be taking home $2,900 per month after paying taxes on that income. Being in that position is risky since you won't have the cash flow necessary to cope with unexpected expenses or put money away for the future.
Way To Calculate Your Maximum Affordable Monthly Mortgage Payment
Achieving a desirable debt-to-income ratio (DTI) is one of the best ways to determine how much of a mortgage you can afford and, ultimately, what sort of home you should look for. After you have determined the amount of the monthly payment that you can pay, you can use a mortgage calculator to determine the total amount of the mortgage and the amount of the down payment that will get you to the amount of the monthly payment that you can afford.
