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Understanding how much mortgage you can afford comes down to what percent of income should go to mortgage payments. How do you calculate this amount? First, you need to know what’s included in a mortgage payment and why debt-to-income (DTI) ratios are important.

What is included in a mortgage payment?

A mortgage payment is made up of four components, often referred to as PITI: principal, interest, taxes and insurance. Here’s a breakdown of each component:

• Principal: The original amount of your loan before interest.
• Interest: A percentage of the principal that you pay to the lender. Mortgage interest rates can be fixed or variable.
• Tax: Yearly property taxes are paid monthly and are considered part of your mortgage payment.
• Insurance: Your monthly homeowner’s insurance payment is also considered part of your mortgage payment.

Understanding what is included in a mortgage payment will help you accurately budget a percentage of income for mortgage. For example, if you forgot to include insurance and tax payments in your mortgage payment estimate, you might budget for more than you can afford. Note that your mortgage payment does not include home repairs and maintenance costs. Those are personal expenses you’ll have to budget for separately.

How much of your income should go to mortgage payments?

Now that you know what’s included in a mortgage payment, it’s time to consider how much mortgage you can afford. Debt-to-income ratios can help you calculate what percentage of your income should go to your mortgage. To calculate this, you need to be familiar with two types of DTI ratios: back-end ratios and mortgage-to-income ratios.

Back-end ratio

A back-end ratio calculates the percentage of your gross income (pre-tax income) that goes toward all your debt payments. This includes mortgage, student loan, credit card, auto and any other payments. To calculate your current back-end DTI ratio, divide your total monthly debt payments by your monthly pre-tax income. It helps to start by making a list of your monthly debt expenses and their minimum payment amounts.

Debt payments may include:

• Mortgage payment
• Car payment
• Student loans
• Credit card payments
• Child support and alimony payments
• Other monthly debt expenses

Your back-end DTI ratio shouldn’t exceed 36% of your pre-tax income. The higher this ratio, the less disposable income you have to put toward your mortgage and other expenses.

Mortgage-to-income ratio

A mortgage-to-income ratio, also known as a front-end debt-to-income ratio, calculates the percentage of your gross income (pre-tax income) that exclusively goes toward your mortgage payment. You can calculate your mortgage-to-income ratio by dividing your total monthly mortgage payment by your monthly pre-tax income. This is a key ratio to understand if you’re wondering what percent of income your mortgage should be.

Using a mortgage-to-income ratio, no more than 28% of your gross income should go toward your mortgage payment—including principal, interest, tax and insurance payments. However, there are multiple factors to consider when budgeting to buy a home.

Other mortgage-to-income budgeting considerations

While it’s suggested that up to 28% of your pre-tax income go toward your mortgage, everyone’s financial situation and goals are different. Below are some additional factors to consider when determining what percentage of income should go to mortgage payments.

Current debt-to-income ratio

Your current back-end debt-to-income ratio impacts the amount of money you can put toward your mortgage. The lower this ratio, the more money you can comfortably put toward your mortgage payment each month. If you have a high back-end DTI ratio, it may make it more difficult to get a mortgage. 

Lifestyle and other expenses

When you’re ready to buy a house, a budget can help you understand how much mortgage you can afford. Even if you qualify for a large mortgage loan, you want to make sure you can afford the payments. Having a monthly budget helps you understand your financial capabilities. Track your monthly spending to see what percent of income you spend on each of the budget categories below.

Example monthly budget percentages:

• Savings - 20%
• Mortgage/ housing - 25%
• Other debt - 10%
• Food - 10 to 15%
• Utilities - 5 to 10%
• Transportation - 10%
• Insurance - 15 to 20%
• Entertainment and personal spending - 5 to 10%

Financial goals

What are your financial goals? Are you set on paying off your student loans? Buying a home? Having clear financial goals will help you determine your mortgage-to-income ratio. If you want to put a full 28% of your income toward your mortgage, for example, you might have to cut back on dining and entertainment expenses to put extra money toward your monthly payments.

Types of mortgage loans

In addition to your mortgage-to-income ratio, it’s also important to research different kinds of mortgages. There are many types of mortgage loans you can choose from, such as conventional mortgage loans, adjustable rate mortgages (ARMs) and affordable home loan programs, to name a few. Research the best loans interest rates, length and terms for you.

Are you ready to buy a home?

Do you need help buying a home? Cadence Bank’s mortgage experts are happy to help. Contact us today to learn about our mortgages and the competitive rates we offer.

This article is provided as a free service to you and is for general informational purposes only. Cadence Bank makes no representations or warranties as to the accuracy, completeness or timeliness of the content in the article. The article is not intended to provide legal, accounting or tax advice and should not be relied upon for such purposes.