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What Percentage of Income Can You Afford for Mortgage Payments?


This question often comes up among first-time home buyers: What percentage of my monthly income can I afford to spend on my mortgage payment? Does that percentage include property taxes? Private mortgage insurance (PMI) or homeowners insurance?

Most agree that your housing budget should encompass not only your mortgage payment (or rent, for that matter), but also property-taxes and all housing-related insurance — homeowner’s insurance as well as PMI. As for just how big a percentage of your income that housing budget should be? It all depends on whom you ask.

In this article on how the mortgage crash of 2008 changed rules for first-time home buyers, the New York Times reported:

If you’re determined to be truly conservative, don’t spend more than about 35 percent of your pretax income on mortgage, property tax and home insurance payments. Bank of America, which adheres to the guidelines that Fannie Mae and Freddie Mac set, will let your total debt (including student and other loans) hit 45 percent of your pretax income, but no more.

Let’s remember that even in the post-crisis lending world, mortgage lenders want to approve creditworthy borrowers for the largest mortgage possible. I wouldn’t call 35 percent of your pretax income on mortgage, property tax, and home insurance payments “conservative”. I’d call it average.

On the flip side, debt-hating Dave Ramsey wants your housing payment (including property taxes and insurance) to be no more than 25 percent of your take-home income.

Your mortgage payment should not be more than 25 percent of your take-home pay and you should get a 15-year or less fixed-rate mortgage…Now, you can probably qualify for a much larger loan than what 25% of your take-home pay would give you. But it’s really not wise to spend more on a house because then you will be what I call “house poor.” Too much of your income would be going out in payments, and it will put a strain on the rest of your budget so you wouldn’t be saving and paying cash for furniture, cars and education.

Notice that Ramsey says 25 percent of your take-home income while lenders are saying 35 percent of your pretax income. That’s a huge difference! Ramsey also recommends 15-year mortgages in a world most buyers take 30-year mortgages. This is what I’d call conservative.

Not everybody is as debt-adverse as Ramsey — and following his one-size-fits-all advice has risks. You just have to remember: the more you spend on your home, the less you have available to save for everything else. You may be able to afford a housing payment that is 35 percent of your pretax income today, but what about when you have kids, buy a new car, or lose your job?

Another reader put it this way:

  • Your mortgage payment should be equal to one week’s paycheck.
  • Your mortgage payment plus all other debt should be no greater than two weeks’ paycheck.

That’s on the conservative side, too. One week’s paycheck is about 23 percent of your monthly (after-tax) income.

If I had to set a rule, it would be this:

  • Aim to keep your mortgage payment at or below 25 percent of your gross monthly income.
  • Aim to keep your total debt loan at or below 33 percent of your gross monthly income.

As some commenters have pointed out, while it may be possible to buy a decent home in a small midwestern town for $100,000 and well within these ratios — workers in New York or San Francisco will need to spend five times that amount just to get a hole in the wall. Yes, people tend to earn more in these high cost-of-living areas, but not that much more. Does it mean they shouldn’t buy a home? Not necessarily, they’ll simply have to make trade-offs to buy in those areas.

Just remember that when you obtain mortgage pre-approval, lenders will likely approve you for a loan amount with payments of up to 30 or 35 percent of your pretax income. That may tempt you to take on more home than you should. Don’t just assume “if the bank approved it; I can afford it”. They are two very different things.

Originally published Sep. 15, 2009.

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. I’m gonna stir the pot here a bit: If you’re conservative and shoot for 25% of your income for mortgage payments and you live in or near a major, expensive metropolitan area, you’re never going to buy anything. And waiting for forever may be more damaging in other ways down the road, especially when real estate prices are going to be somewhat depressed for the next couple years.

    There’s some risk involved in almost any financial decision and there’s obviously risk involved in home ownership. But similarly, sitting on the sidelines for forever because you need to wait until you’re making two hundred grand to be able to afford a starter condo just isn’t realistic. In and around cities like San Francisco, Boston, or New York, you pretty much need to stretch to the very top of your range to afford much of anything unless you make well, well into six figures.

    • My recommendation is that one should stay at or below 31% of their monthly take-home (net) pay for all of the following combined expenses: mortgage, real estate taxes, homeowner’s insurance, car payment, and car insurance. By doing this, and eating out very infrequently (including packing lunches for work and/or school), one can invest plenty into their retirement accounts and save for necessary home repairs/improvements, etc. In addition to all of the above, one should have at least 7-12 months of net pay in a savings account for emergencies.

      • Like Jason said…even at 31% of take-home…that’s insanely low in anyplace like San Francisco, New York, Los Angeles, etc, etc. You MIGHT be able to get a real junky starter-condo for that…which would be a horrible decision as well.

  2. David Weliver says:

    Touché, Jason. The market you’re trying to buy into will dictate how much you have to spend, and I wouldn’t tell somebody to postpone buying forever to wait until they can meet such a stringent budget.

    I can, however, imagine Dave Ramsey’s rebuttal: “Then move somewhere else!” Obviously that’s not the answer.

    His recommendation of 25 percent of take-home income is extremely conservative and, for most, probably the floor of what they would consider spending. My hope was simply to point out that going from his advice to lenders’ criteria—35 percent of gross income—is a big, big leap!!

  3. I have a mortgage payment that is 22% of my pre-tax income including all taxes and insurance and I’m comfortable with that. I live in a respectable house in a good neighborhood. 35% seems high to me if you have a car payment and student loans especially. Also, I could barely rent in my area with 25% of my take-home pay like Ramsey says. I think a better guideline would be 25% of pre-tax income not 35%.

  4. Dave Ramsey’s system potentially can make some people worse off in the long run.

    For example, if someone who “shouldn’t” buy a home (according to Dave’s Rules) never buys a home, in the long run they could be worse off due to (1) never building any home equity, and (2) paying ever-rising rents, thus hindering their ability to save and invest.

    Dave says that renting often makes sense in the short term, but isn’t a good long-term housing strategy. But Dave’s Rules set up many people to fail financially in the long run.

    • Agreed. Dave’s scenario could work if someone made a quarter million dollars a year, but how many American’s make that kind of money? You’ll pay just as much in rent these days as you will on a mortgage so what is the point in doing so when a mortgage at least retains some value? According to Dave a person making just over $100,000 can only afford $180,000 home. Depending on the area, this could buy you a decent three bedroom home or a terrible apartment in the slums. Either way you would think that the top 15% could afford something a little nicer. For me, someone who only makes $50,000, I would only be able to afford a $100,000 home. Unless the house is foreclosed in a high crime neighborhood I will not find a house at that price, believe me I’ve looked. Rent is a waste; I can’t find an apartment under $800 dollars.

      What it really comes down to is preference and responsibility. Some would rather prefer living in a nice neighborhood with good schools for their children while sacrificing other things like new cars, pricey vacations, and eating out. Others would rather have the new cars, pricey vacations, and eat out every other night while living in a cardboard box. It doesn’t really matter which one you choose as long as your happy.

  5. There is a huge difference between the two methods. Assuming you don’t include insurance and taxes in the 35% of pre-tax scenario, if you make $100,000/yr married, you’re looking at a $486,000 home. For 25% of post-tax at $100,000/yr married including insurance and taxes (0.5% and 0.75% annual based on home price, respectively), you’re looking at a $182,000 home. THAT IS A HUGE DIFFERENCE. A $300,000 difference! Note that all these calculations were done based on 6% interest and don’t include down payment information.

    Personally, I’d like to stick to Dave’s rule. I know there are some markets where this may not be possible, but in the midwest, even with a $20k/yr job, you could get a house for this much. Yes it would be a very small house probably not in your first choice neighborhood. Yes, you’d have to shop around a lot to find it. But yes, it is doable. I don’t buy the “It’s not possible” line. We don’t NEED huge houses with 1+ rooms per person. What we NEED is a place that will protect us from the elements where we can lay our heads, cook food, and stay healthy (hygiene). There are many MANY cultures around the world that do just fine with much less than what Dave talks about. I’m not saying we should turn into a third-world country, but I certainly think we as Americans have gotten way out of control in what we spend on shelter… as if a larger house will somehow make us happier and get rid of our problems.

    • “but in the Midwest, even with a $20k/yr job, you could get a house for this much.”

      I hope you’re exaggerating. I live in St. Louis, MO and 25% of your post tax monthly income on a 20k per year job would be about 360 bucks. That wouldn’t get you a studio apartment in the ghetto much less a house. Unless you’re talking about the poorest poedunk rural area in the country, $360 a month will not cover a mortage payment, taxes, and homeowners insurance and PMI. Unless maybe you’re planning on buying an “outhouse”.

      • tom isenbach says:

        Agreed. I can’t tell you how ridiculous this 20-25% of your post tax figure is. If real estate prices were more in line with what they were in the 1980’s this MIGHT be possible. People that make $60,000(for example) per year in St. Louis do not want to live in complete filth in an undesirable area. By following this ridiculous rule of thumb, that is what you would get if you made around that amount per year. I’d say if you do not have a lot of debt, 20-25% of your PRETAX income is just fine. You are not going to have a financial crisis and you will still be able to take your pick from many desirable neighborhoods.

        • I’m not sure the 25% of post-tax income is quite so ridiculous. My husband and I live in Charlotte NC (not cheap by any means but not extremely pricey – a good sample) and together, we make $100,000 annually. After taxes, our net income is right at $5500/month.

          We live in a very desirable suburb of Charlotte (15 minutes outside the City Limits) and paid $190,000 for our house. We put a little over 20% down ($40,000) and took out a 20 year mortgage. Our mortgage payment is $880/month. Our taxes & insurance are $210/month for a total of $1090/month. That’s less than 20% of our net bring home. Buying a home at 35% of our pre-tax income would put us in a $2700/month house – no thank you. With our bring home, after paying our mortgage, we would be left with $2800/month to pay other bills, save money, buy a car when we get ready to, go on vacation, etc. That’s not comfortable.

          35% of our pre-tax monthly income is actually 50% of our bring home after taxes, and quite simply, isn’t doable for us. It doesn’t seem like it’d be doable for any typical, successful couple who isn’t making at least $250,000+ annually.

          It’s easily doable in some parts of the country – maybe not in other areas, but as a whole, I think staying at or around 25% of net income is doable. I certainly feel that 35% of your pre-tax income truly is way too much money to put towards your mortgage unless you never ever plan to need to buy a car, send your kids to private school, pay for college or buy anything else until your mortgage is paid off.

    • elisssabeth says:

      Au contraire…A larger house DOES make us happier. Last year we moved our 4 person, 2 dog family FROM an 1800 sq foot bungalow in a densely-packed blue collar neighborhood with narrow, unwalkable streets and no sidewalks, TO a 2900 sq ft house with quiet neighbors, plenty of space between the houses, wide enough streets to safely walk with our dogs and kids…and the lowering of everyone’s stress level is palpable. We are no longer telling the dogs to get out of the way ALL DAY LONG, or trying to do laundry in a closet in the one hallway where everyone has to walk to get anywhere. Blood pressures are definitely down. That’s worth $ to me. LOTS of $.

  6. My wife and I are looking into what will be our second time buying a home. We sold our first home almost 2 years ago in 2008 because we relocated for my career. We didn’t make any money on the home sale but we didn’t lose any money either, so all-in-all I call that a huge positive for us. We’ve been sitting on cash for 2 years with absolutely zero debt.

    Now however, we are looking to purchasing again and the dilemma I’m finding is that we could spend about 34% (income before tax) which would include PMI, Ins, HOA … every but basic utilities -Which we’d pay no matter where we live- on an excellent home on a nice golf course, pool, city view, etc.

    -Or- we could pay significantly less than the 34% (as explained above) on more of a very basic home. I’m concerned that a very basic home (getting us closer to 25% or less) would be much more difficult to sell in future years because it seems so much less desirable. Granted it would be much cheaper and probably free up a lot of cash flow.

    It just seems like the 34% home is a real gem whereas the basic homes would be much more inexpensive but … well it just seems as though the house with the pool on the course is tremendously marketable whereas any of the basic homes would look like just another home on the market if I want to sell in a few years.

    Any thoughts?

    • rvaughnp says:

      For all of those that are arguing about purchasing a home in the 35% pretax area… I would watch the news a little before that purchase; especialy here in the next few months when the re-reforclosures start coming in. Most of all the forclosures where purchased under those guidelines. Nothing like seeing your homes market price drop after your recent purchase, to around 30%-50% from what it was purchased for one year to five years after your purchase.

      The problem is that laws have been passed that allow city and state governements to increase the tax burden on our homes instead of letting the market work itself out.

      My 2800 sq ft home in Midland,TX that is taxed at 185,000 here(which I purchased at 170,000 (07′) just three yeras ago) would cost 145,000 in Arlington,TX and probably 350,000 or more in LA,CA. We don’t get to make the market the government does by continually increasing the tax rates and appraisals.

      Sorry to get off subject. But it needed to be said… a house that is appraised today at 300,000 in five year will be 400-450,000 in 7 years. Will the adjusted mortgage payment (with new tax payment increase added in) still be affordable?

      • Michelle R says:

        Unfortunately we bought at the top of the market in Pennsylvania, our 2600 sq ft home was 512,000 now worth 475,000.
        I just figured out that we are at 38%, due to my husbands job change/cut in pay. But after discussing (should we sale?) we realized we lost a good amount of equity already and decided to calculate 10% as an investment. (15% is standard percentage for investing) and the other 5% into 401 until I return to work.

        This is an area we plan to be here for the long term, watch our kids grow old here and sale it when we retire. Also, when I go back to work we plan to pay the mortgage off in less than 15 years.

        I’m know I’ve rambled but the point is the %’s are just guidelines and you have to do what works for you and meets your long term goals.

    • Pamsthoughts says:

      I felt this way and still struggle with the same dilemma. As a former Realtor and a home seller
      dont be fooled by its a great investment for resale. My husband and I fell into the same scenario and thought the home we currently have would be better for resale and statistics in the future, in a similiar setting as to what you described.
      Boy were we wrong, we even bought at the “low” price point in a declining market. Our home after one year is worth 60,000 less currently than what we paid a year ago.
      We currently have it for sale due to a job transfer for my husband’s job and even with relocation assist with his company we are having to take a substantial loss.
      I learned my lesson and the next home we buy will be smaller and in a neighborhood that most people can afford to buy in. I will not make the same mistake twice. The cash flow is much more important than living in a upscale neighborhood to us now.
      Anyway good luck with what you decide but please dont base your decision based on resale potential, nothing is guaranteed in this market .

  7. Well, I’ll stir the pot a little bit too. I think it’s kind of funny that pretty much all the comments on here are how to justify more debt and be less conservative with our spending, yet we’re in the middle of an economic crisis brought on largely because too many people wanted that house with the pool next to the golf course and didn’t have the means. Their yearnings exceeded their earnings, but they just had to have it and here we are. I’ll stick to the conservative side of finances. 25% is a big plenty for me, but my wife and I don’t need status symbols to be happy, so I guess we’re lucky there. Jobs and earnings are fragile, undulating things, but debt is always there and doesn’t care if you have a bad month! I think a lot of headaches and even divorces could be avoided by being conservative and putting a little extra in the bank.

  8. I am currently struggling with this problem as well. My wife and I have been married for 3 years and have YET to get into a home due to constant apprehension on what we should/could spend and unstable employment. The strain on our relationship comes from NOT having a home and having to rent my father’s basement for 3 years longer than we intended. We are now at a point where we are financially ready to buy a home but the 25% of net income rule is virtually impossible in the Chicagoland area. Without having to buy a dump that we will have to sink thousands into anyway, I figure we can handle a mortgage that is roughly 30% of our GROSS income. We have about 10-12% down payment and no debt whatsoever. I’ve been over the math hundreds of times, am I crazy for thinking this is possible or am I making a smart investment?

    • Usually minimum to put down is 20%. Why not put at least 20% or heck save a little more and put down 25-30%. This would lower the 30% of your gross income. It’s not impossible it’s just your putting down a very small percentage of money. Now I know you think wow that 2 or 3 times as much as we have saved. Tighten up your budget and save more. If it takes another year or 2 years so you can have more money in your budget I don’t see what the problem would be.

  9. Katrina Reuben says:

    Should we consider the home owners insurance cost with the 25% take-home pay threshold you stated we should be meeting before considering refinancing?

  10. My mortgage (MTI) is 20% of my take home pay, and that’s after me contributing 6% to my 401k. It’s what has allowed me to be on track to pay off $40k in student loans in one year. In fact, the mortgage is such a small factor for me, that I could easily pay it off before I turn 30. I highly recommend the 25% take home pay rule. It’s definitely feasible if you don’t get suckered into the bigger, nicer, better location gimmick.

  11. just checked to see what % my mortgage is of my take home pay. 14.1% that includes insurance and taxes. Its a nice house, I make decent money. Neither of which is over the top. Buying after the market crashed makes a huge difference.

  12. I think the bigger question isn’t necessarily “how much of a mortgage can you afford” but rather, “how much do you really need”? You might be able to afford to spend 20-30 percent of your income on your mortgage, but perhaps (based on the size of your family) you only really need a scaled-down home that costs 10 percent of your income. There’s no reason to buy “more” home than you need, even if you can afford to do so.

  13. Yes, most people seem to buy way to big of a house that they can’t afford. I see it all the time where people buy this expensive house that costs them 40% or so of there income. Than they buy this SUV brand new that they had to have for there family for another $35,000. Than next thing they know they loose there job because there is some one out there that does it better than them. Well what do you know this person had no savings what so ever to fall back on. I say If you want a big house for more than 25-30% of your income put more cash down on it. It’s not hard people to save. Im military make $45,000 a year married, my wife does not work. We have 2 cars paid off live in a 3 bedroom house we rent. Right now $900-1100 a month for savings. Live with in your means with homes, cars and all purchases. I feel all these people saying 25% rule is crazy are the ones that will be in struggle later on. Like I said why not just put more money down on the home. I was thinking of buying, but I move every 3 years or so. So for me maybe not the best option.

  14. This is all very interesting to me. I think it comes down to what makes us comfortable from an individual standpoint. My wife to be and I always think that if you grew up with debt, credit cards, student loans etc it is easier to take larger loans out, or at least you feel more comfortable with it, not sure how true that may actually be. The two of us have been very fortunate and have not had any debt or loans until we bought cars and recently purchased a house. Running through the numbers (including taxes and insurance) our yearly mortgage comes to 10% of pre tax dollars and 16% of take home. I would say this is conservative but we simply didn’t feel comfortable with a mortgage that was much more than what we ended up with.

  15. I would have to agree with the 33% rule as a max. I would also recommend that first time home buyers set aside a 3 month mortgage cushion besides the original emergency fund they had before buying the home. It will provide peace of mind with all the unexpected things home owners will face.

  16. FrustratedinDC says:

    As the article notes, it’s fine to be conservative if you live in most areas. I live in the Washington, DC metro area, where conservatism isn’t in the cards–unless you happen to be wealthy. If you want decent schools, you need to live in a suburb like those in Montgomery County, MD. The cheapest house in Montgomery County, MD that would be suitable for a 4-person family–3 bedrooms, 1200 square feet, still pretty far from the city and quite a miserable looking little hole–is on the market for $379,000. Assuming they make a 20 percent down-payment, the family that buys this house would have to take out a $300,000 mortgage. That means monthly payments would stack up to about $1870/month, even at today’s very low interest rates. To stay at 25% of pre-tax income, you’d have to earn about $90K a year. If we use net income as our measure, then the family would have to earn substantially more than that.

    So in areas like DC, New York City and San Francisco, fiscal conservatism is a privilege of the wealthy.

    As for moving–that wouid be an attractive option, if only jobs were plentiful elsewhere.