Buying a home for the first time can be daunting. How much house can you afford? What percentage of income should even go toward that monthly mortgage payment? If you have no idea, you’re not alone. In a recent survey done by Wyndham Capital Mortgage, 23 percent of those surveyed didn’t know the answer either.* In a nutshell: It depends on your level of debt.
Once you understand the guidelines mortgage lenders use and the steps to calculate gross monthly income, you can go back to focusing on finding that house with the open floor plan or the spacious walk-in closet of your dreams.
What percentage of income should go to a mortgage?
Most lenders agree that if you have debt, such as credit card bills or a car payment, no more than 28 percent of your monthly gross income should go toward your mortgage payment (including principal, interest, taxes and insurance). For borrowers without debt, some lenders will approve using up to 41 percent of your income, according to the Federal Housing Association (FHA).
What is your gross monthly income?
Before we dig into the details of the guidelines mortgage lenders use, let’s get a handle on gross monthly income. Gross income is the money you earn –– whether it be from sources such as salary, profits, tips, alimony or freelance work –– before taxes and deductions for benefits such as health insurance are taken out.
For an employee who is paid a salary, calculating your gross monthly income takes one simple step:
Annual Salary Before Taxes / 12 = Gross Monthly Income
If you are paid hourly, there are a few extra steps required to calculate gross monthly income:
Step 1: Hourly Rate x Number of Hours Worked Per Week = Weekly Salary
Step 2: Weekly Salary x 52 (number of weeks in a year) = Annual Salary
Step 3: Annual Salary / 12 = Gross Monthly Income
What are the income percentage guideline rules of thumb?
You’ve calculated your gross monthly income but before we move on, it might be helpful to understand why lenders set these guidelines. The answer: They want to make sure you can pay back your mortgage. Fair enough, right? The best option is to purchase a home you can afford.
Want to know how much you could afford on a mortgage? Calculate 28 percent of your gross income. Here is an example. Say your gross monthly income is $5,000. Multiply it by 28 percent (or .28) to calculate how much you should spend on a monthly mortgage payment.
$5,000 x .28 = $1,400 (This includes mortgage, principal, interest, taxes and insurance.)
Your income isn’t the only factor. Potential lenders also want to know how much money you spend compared to how much you make. This is the Debt-to-Income ratio (DTI). What’s the general rule of thumb? Lenders prefer to see a DTI smaller than 36 percent of your gross monthly income. Monthly Gross Income x 36% = Debt Payments
You don’t want your debt to exceed that 36 percent, so the first thing you need to do is add up the monthly payments calculated into your DTI, including but not limited to:
- Rent or monthly mortgage payment
- Homeowners insurance
- Monthly homeowners’ association fees
- Auto loan payments
- Credit card payments
Debt Payments / Gross Monthly Income = Debt-to-Income ratio
Tips to Maximize Your Budget
Knowing where you spend money every month is key when planning to purchase that first home, so you want to get a handle on your budget. Increasing your gross monthly income is one way to improve your DTI. But if that’s not possible, reducing your monthly debt will help. Here are some tips:
- Pay down debt: Make an extra payment one month and consider adding it to your principal You’d be surprised how quickly you can decrease your overall debt. But don’t forget to check if there are any prepayment penalties.
- Consolidate debt: Consolidate all those high-interest debts into a consolidation loan with a lower interest rate. Keep in mind, this may cause a temporary dip in your credit score.
- Cut out bad habits: Whether it is impulse buying or paying for streaming services you rarely watch, reducing those monthly credit card charges ultimately means less debt.
At Wyndham Capital Mortgage, we want our borrowers to feel comfortable purchasing that first home. Understanding how you could reduce monthly debt payments and the guidelines mortgage lenders use to determine the percentage of income that should go toward a mortgage could help you buy that dream home. If you have any questions, reach out to your loan officer today.
*Wyndham Capital Mortgage commissioned Atomik Research to run an online survey of 2,342 adults in the United States for their Mortgage 101 survey. The margin of error fell within +/- 2 percentage points with a confidence interval of 95 percent. The fieldwork took place between March 23rd and March 29th, 2021. Atomik Research is an independent creative market research agency.