How Much Should My Mortgage Be Monthly by Rule of Thumb?
During the real estate bust of the late 2000s, thousands of people lost their homes because they couldn't afford their monthly mortgage payments. Whether they had been the recipients of bad advice from their real estate professionals, the targets of unscrupulous lenders who knowingly qualified them for loans they couldn't afford or the victims of their own bad judgment, many of these former homeowners would have been spared the pain and financial burden of foreclosure if they had heeded simple, time-heralded rules of thumb when calculating what they could afford for a mortgage.
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Mortgage Debt
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The first thing to consider when contemplating a new mortgage is how much your new debt will be compared to your monthly income. This is called your debt-to-income ratio, and there are two calculations you should take into account. The front-end ratio shows how much of your pre-tax monthly income goes to your mortgage payment. Standard advice is that no more than 28 percent of your pretax, or gross monthly income, should go to housing expenses--including principal, interest, property taxes and homeowners insurance. But some lenders will approve front-end ratios as small as 25 percent or as large as 33 percent.
Total Debt
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The second debt-to-income ratio to consider is called the back-end ratio, which refers to how much of your gross monthly income goes toward total debt. To find your back-end ratio, add up all your monthly payments for your car, student loans, credit cards, child support or alimony fees and homeowners' association dues. This number, combined with your new mortgage payments, should not exceed 36 percent of your monthly income, according to the traditional rule of thumb. Taking the back-end ratio into account should show you to take on smaller monthly payments if you already have a lot of other debt. Conversely, if you are mainly debt-free in the rest of your life, you might be able to spend more on a mortgage.
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Other Considerations
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Traditional debt-to-income ratio calculations don't take into account the money you might want to spend on other goals, including retirement and college savings, vacations, renovations and expanding families. To get a truer estimate of how much you can afford, calculate your monthly budget for all of these expenses and any you hope to take on over the term of your loan. Add this number to your total debt when you are calculating your back-end ratio. Couples who want to have the option of having one partner leave the workforce or work part-time while their children are young should also calculate their debt-to-income ratio based only on the income of the partner who plans to continue working.
When to Stretch
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While most homeowners will want to take on as little monthly mortgage payments as possible, there are a few situations that can justify spending a little more. Homeowners who know they won't have a lot of other monthly expenses, especially those who don't plan to have children or who don't have to invest in their own retirements because they have an employer-provided pension, can spend a little more on their mortgage--think front-end ratios in the low 30 percent range. Also, homeowners who are extremely certain that their income will rise substantially in the first years of their investment can take projected earnings into account.
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References
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