When you’re buying a home, it’s important to consider the breakdown of your monthly expenses alongside the overall cost. One of the largest and most significant expenses you’ll pay each month after purchasing a home is a mortgage.
Knowing how much of your monthly income you can put toward your mortgage payment will likely help you decide if this is the house you want to live in or buy as an investment.
In this article, we’ll take a look at some of the general rules and formulas you can follow to calculate your mortgage-to-income ratio and determine how much home you can afford.
Most people will make one of the biggest financial decisions of their lives when they buy a house. To avoid overextending your finances, it’s important to know how much house you can actually afford. This is where the 35/45 rule comes in handy. This guide will tell you what the 35/45 rule is, why it’s important, and how to use it to figure out how much house you can really afford.
What Is the 35/45 Rule?
The 35/45 rule is a guideline that recommends your total monthly housing costs should not exceed 35% of your gross monthly income. Gross monthly income is your total pay before taxes and other deductions.
Your total monthly debt payments, which should include your rent and other debts like credit cards and auto loans, shouldn’t be more than 45% of your gross monthly income.
So in short:
- Housing costs ≤ 35% of gross monthly income
- Total debt ≤ 45% of gross monthly income
This rule aims to prevent you from spending too large a portion of your income on housing and other debts, helping avoid becoming “house poor.”
Why Is the 35/45 Rule Important?
Following the 35/45 rule is important for several reasons:
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Keeps you from taking on too much debt: the more of your income you spend on housing and debt, the less you have for other things, like savings for retirement, college, or a rainy day. Following the 35/45 rule will help you avoid spending too much on housing.
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Reduces financial risk – If you lose your job or have an unexpected expense, having less going toward debts gives you more flexibility in your budget. This provides a safety net.
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Helps you get the best mortgage rates—lenders look at your debt-to-income ratio when they give loans. Your chances of getting approved and getting better rates go up if you keep your ratios low.
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Allows room for other costs of homeownership – On top of your monthly mortgage, you’ll have utilities, repairs, homeowners insurance, and property taxes. The 35/45 rule accounts for these extra costs.
How to Use the 35/45 Rule to Determine Affordability
Figuring out your affordable housing budget using the 35/45 rule is straightforward:
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Calculate your gross monthly income. This is your total pay before taxes and deductions.
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Multiply your gross monthly income by 0.35 (35%) to find your maximum monthly housing costs.
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Add up your estimated monthly costs for things like mortgage principal/interest, property taxes, homeowners insurance, and PMI. This is your total monthly housing cost. It should be equal to or lower than the figure from step 2.
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Multiply your gross monthly income by 0.45 (45%) to find your maximum monthly debt obligations.
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Add up your monthly debts including housing costs, auto loans, credit cards, student loans, and any other debts. This amount should be equal to or lower than the figure from step 4.
Let’s look at an example:
- Gross monthly income: $6,000
- Maximum monthly housing cost (0.35 x $6,000): $2,100
- Total estimated housing costs: $1,800
- Maximum monthly debt (0.45 x $6,000): $2,700
- Total monthly debts: $2,500
Since the total housing costs and debts fit within the limits calculated using the 35/45 rule for this sample income, this budget aligns with the guideline.
Key Factors to Consider
When using the 35/45 rule, keep the following factors in mind:
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Down payment – A larger down payment reduces the mortgage amount borrowed, lowering monthly costs.
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Interest rate – Lower rates reduce monthly mortgage payments, allowing more room in your budget.
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Loan term – A longer term lowers payments but increases total interest paid over the loan’s life.
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Location – Housing costs vary greatly by location. Adjust estimates accordingly.
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Existing debts – Current debts impact how much you can allocate toward housing.
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Retirement savings – Don’t forget to budget for retirement accounts like 401(k)s and IRAs.
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Lifestyle – Your individual lifestyle and expenses also influence your ideal budget.
Tips for Lowering Housing Costs
If your estimated housing costs exceed the 35% threshold, here are some tips to lower your monthly housing payments:
- Make a larger down payment to reduce the mortgage amount
- Shop around for the lowest interest rate
- Choose a longer loan term such as 30-year instead of 15-year
- Opt for a less expensive home or live in a lower cost area
- Request a property tax reassessment to potentially lower taxes
- Refinance your mortgage if rates have dropped since you got your loan
The 35/45 Rule: A Valuable Affordability Check
When determining your home buying budget, the 35/45 rule serves as a preliminary guideline to help prevent overextending your finances. While not a hard-and-fast requirement, it provides a baseline to assess affordability based on your income, debts, and other factors. Use it as a starting point, and adjust your budget to suit your unique situation. With some planning and number crunching, the 35/45 rule can give you greater confidence that you’re making a responsible home purchase decision.
What percentage of your income should go to your mortgage?
To determine how much income should be put toward a monthly mortgage payment, there are several rules and formulas you can use. The most popular is the 28% rule, which states that no more than 28% of your gross monthly income should be spent on housing costs.
Although most personal finance experts recommend the 28% rule, there are several other rules and guidelines that can be helpful in your calculations. Let’s take a look at a few.
What’s included in a monthly mortgage payment?
To understand how much of your income should go to a mortgage, it’s helpful to understand the components that make up a mortgage payment. Each month, a portion of your payment will go toward PITI – principal, interest, property taxes and homeowners insurance.
Also, if you make a down payment of less than 20%, you’ll have the added fee of mortgage insurance tacked onto your payment each month. This type of insurance protects lenders’ investment in the event that you default on the loan. For a conventional loan, this is usually paid in the form of private mortgage insurance (PMI).
Understanding The 35 45 Rule For Mortgage Eligibility
FAQ
What is the 35 45 rule for mortgages?
The 35/45 rule, used in mortgage calculations, suggests that your total monthly debt, including your mortgage payment, should not exceed 35% of your gross (pre-tax) income or 45% of your net (post-tax) income.
Can I afford a 400k house with an 80k salary?
A person usually needs to make between $100,000 and $125,000 a year, which is about $8,333 to $10,417 a month, in order to afford a $400,000 house.
What salary do you need for a $500000 mortgage?
A $500,000 mortgage payment might be as low as $3,045 if you put a lot of money down, pay low property taxes, and get cheap insurance. The 28/36 rule says that your gross monthly income should be $10,876, or a little more than $130,000 a year.
Can I afford a $300 k house on a $70 k salary?
Can I afford a $300K house on a $70K salary? If you have minimal debts then a $70,000 salary might be enough to afford a $300,000 house. The size of your down payment and your mortgage interest rate will be important variables. Try to keep your monthly house payments below a third of your monthly gross income.