If you’re in the market to purchase a new home, the question you are probably asking yourself is what percentage of my income should go towards my mortgage payment.
Mortgage lenders have a maximum debt-to-income ratio of 28%.
Meaning if you make $100,000 per year before taxes, your mortgage payment cannot exceed $2,800.
But not everyone agrees.
Dave Ramsey suggests that your monthly mortgage payment should not exceed 25% of your after-tax income.
Let’s dig into the numbers to find out.
Rate Search: Shop and Compare Mortgage Rates
Know Your Debt-to-Income Ratio
Your debt-to-income ratio, or DTI ratio, is the amount of your monthly debt obligations compared to your monthly gross income.
Front-end DTI Ratio – Your front-end DTI ratio is your mortgage payment amount compared to your monthly pre-tax income.
Back-end DTI Ratio – Your back-end DTI ratio is the amount of your total monthly debt obligations compared to your monthly gross income.
For example: If you have a total of $500 per month in debt payments from your auto loan, credit card minimum payment, loans, etc., and your income is $5,000 per month. Your front-end DTI ratio is 10%.
If your estimated mortgage payment is $1,000 per month, bringing your total debt payments to $1,500. That is 30% of your gross monthly income of $5,000 per month.
Your back-end DTI ratio is 30%, within the range of the 36% DTI ratio lenders want.
So What is the Ideal Percentage of Income that Should go towards your Mortgage?
Dave Ramsey is definitely thinking conservatively when he says no more than 25% of your income should go to housing.
Lenders like to see no more than a 28% DTI ratio, that’s 28% of your pre-tax income. In some cases, the DTI ratio can be as high as 43%.
That’s a big difference.
The truth is somewhere in-between.
And the more money you make, the higher percentage you can afford.
- We suggest you aim for a mortgage payment that is between 20%-28% of your gross income.
- And that your total debt payments do not exceed 50% of your after-tax income.
Don’t Forget to Budget for all Mortgage Costs
A mortgage is more than just a monthly mortgage payment. There are property taxes, mortgage insurance, homeowners insurance, and HOA fees.
Make sure you are using the total monthly payment when figuring out your debt-to-income ratio.
Use our home affordability calculator to see how much house you can afford.
How to Get a Lower Monthly Payment
To spend a lower percentage of your income on your mortgage, you need to get the payment lower. Here are a few tips to reduce your monthly payment.
Improve your credit score
Your credit score is directly tied to the interest rate you receive on a loan—the higher your score, the lower the rate, the lower your payment.
One of the quickest ways to improve your credit score is to pay down your credit card debt. Try to get your total balances below 15% of your credit limits.
Get a 40 year fixed-rate or Adjustable-rate mortgage
By stretching your mortgage loan to 40 years, your monthly payment will be lower. Even though they come with higher interest rates, they are offset by their lower monthly payment.
An adjustable-rate mortgage has a low initial interest rate for a fixed period of time. A 5/1 ARM is the most popular adjustable-rate mortgage. For the first 5 years of the loan, you will have a low rate that allows you to have a lower monthly payment.
Have a 20% down payment
Mortgages require a mortgage insurance premium, PMI. This is insurance on the loan itself, in case the borrower defaults on the loan. However, if you have at least 20% down, you do not have to carry PMI on a conventional mortgage saving you hundreds of dollars per month.