Before purchasing real estate, or before refinancing your home loan, you should determine the percentage of your income that you can comfortably dedicate toward your mortgage. No single number accounts for every household's financial situation, but money experts agree that no prospective buyers should rely on their mortgage brokers or banks to provide a loan that suits their budget and financial goals. Instead, assess your current outstanding debt and income and make a conservative estimate about how much house you can afford.
Online Mortgage Calculators
For the most part, online mortgage calculators operate on a front-end ratio, meaning that they measure your gross income rather than your net income and determine what amount you can afford to dedicate toward mortgage. The calculators typically use 28 percent of your gross income. This figure, however, not only should encompass the principle and interest on your mortgage payment but also other expenses associated with real estate ownership such as property taxes, mortgage insurance and home insurance premiums. If you need to do significant renovations and repairs, you may want to include this figure in your mortgage budget as well.
If you are carrying a significant amount of debt, be it from low-interest student loans or high-interest credit cards, you may benefit from determining your potential mortgage payment using a back-end ratio. A back-end ratio takes into account various ongoing debt obligations, such as mortgage payments, personal loans, car loans, child support, credit cards, student loans and cooperative or condominium fees. In this formula, a 36 percent debt-to-income ratio is the standard in the mortgage industry.
Life throws many variables in your path, and you may want to account for them when you determine your ideal debt-to-income ratio. If you want to pursue investing aggressively, or wish to double up on retirement contributions so you can retire early, account for these lifestyle decisions when you figure your mortgage payment. People who freelance, work on a bonus-driven model, change jobs frequently, or experience wide fluctuations in monthly income may also want to use a more conservative estimate. In these cases, set aside 25 percent of your gross income, either using a front-end ratio or a back-end ratio, toward your mortgage payment and ancillary real estate expenses.
In some situations, going higher than the 28 percent of monthly income figure may be justified. People who have little to no debt load, for example, can afford to devote more income toward housing expenses. Likewise, people who have job security and expect to increase their income regularly can allow for a higher mortgage payment. If you have fully funded your retirement plan or have a secure and generous pension, you can set aside more money for real estate.
Nina Makofsky has been a professional writer for more than 20 years. She specializes in art, pop culture, education, travel and theater. She currently serves as a Mexican correspondent for "Aishti Magazine," covering everything from folk art to urban trends. She holds a Bachelor of Arts in English from Mills College.