Knowing how much you can afford when it comes to your mortgage payments starts with knowing your salary and how much salary should go towards your mortgage so you can afford your dream home whilst still being able to manage all your other living costs. Questions surrounding how much you can afford to borrow, mortgage costs, and what it all means can take the shine off your excitement when you find the perfect home – but don’t let it! To avoid monthly debt, you need to know your mortgage to income ratio, and that’s best expressed as a %.
In terms of the percentage of your salary you’re spending on mortgage repayments each month, most people prefer the cautious route, putting only 25% to 28% of their net monthly pay towards their mortgage payments. That’s net – e.g. not your pre tax income but what you actually take home each month. Still, some people prefer to pay off their mortgages quicker, so they dedicate 35% of their total salary to the loan.
In this guide, you’ll learn everything about loans and how you can calculate the best monthly payments to fit your financial situation, as well as looking at some more crude, but effective, affordability assessment techniques you can use to get a rough idea about what’s affordable for you each month before you apply for a mortgage.
What Percentage Of Salary Should Go To A UK Mortgage?
Mortgage payments depends on things like the term, principal balance (what you borrow), interest rates (and if interest rates rise or fall for those who aren’t on a fixed rate mortgage), etc. Knowing how mortgage payments work will protect you in the long run when understanding what you can afford. Your mortgage broker can help you there.
Assessing mortgage affordability is a crucial part of getting a mortgage. Even if you get the best mortgage deal, you don’t want to bite off more than you can chew and be spending too high a percentage of salary on a mortgage. Therefore, you should take a close look at your expenses, debt, and household income before getting a loan.
Since most mortgages consist of monthly payments, it’s recommended to analyse your monthly salary rather than your overall financial situation to determine exactly how much each month you can comfortably afford.
28% Rule
The rule of thumb when calculating your mortgage is the 28% rule. Experts suggest that your housing costs shouldn’t exceed 28% of your net monthly salary. This includes your monthly mortgage payment, homeowner’s insurance, private mortgage insurance, and any homeowner association fees.
Additionally, you should leave an additional 8% for all your debt, such as credit cards and student loans. Once you put aside 36% of your salary, the rest should be sufficient for daily expenses, an emergency fund, and even extra savings.
35% / 45 % Rule
A similar rule is the 35% rule. Your mortgage payment limit should be 35% of your monthly gross income or 45% of your net after tax income. This rule allows you to decrease the mortgage term, though you might find yourself short on cash at times with so much in outgoings each month.
25% Rule
If the 28% rule still doesn’t grant you enough financial freedom, you might find the 25% rule more suitable. This rule specifies that the limit of all your debt repayments, including mortgages, credit card payments, and other loans, is 25% of your gross monthly income.
While this means you’ll either be looking at extending the mortgage term or reconsidering the property, it’s best to be over-cautious sometimes when applying for mortgages as it protects you against future changes you might face such as loss of job or an expansion of your family.
Mortgage Calculation
Unfortunately, you can’t just pick a property and choose the monthly instalments you’re willing to pay. Instead it goes the other way around, as lenders determine how much they are willing to lend.
For this reason, you need to understand how a mortgage is calculated. Here’s how you can calculate your monthly mortgage payments:
Estimate The Loan Amount
Mistaking the property value for the mortgage amount is a common mistake. Yet, it’s important to understand that the loan amount is different from the property value.
To simplify, the property value is the actual amount the seller expects to receive, whereas the mortgage amount is the actual value of the loan required once the down payment (deposit) has been subtracted from the property value.
Figure Out Interest Rate
Rates in the mortgage market are constantly changing, depending on economic conditions. Mortgage lenders offer different rates and terms based on the borrower. Mortgage lenders have a range of products aimed at a number of different types of lender:
As such, you can get a rough estimate of the interest rate the lender might offer you based on your demographic and credit history. The mortgage’s LTV also plays a crucial role in estimating the interest rate.
Decide On A Mortgage Term
Extending your mortgage terms is the best option for individuals with a limited budget. Additionally, a longer mortgage term results in lower interest rates.
While extending the mortgage term means you’ll pay less each month, so you should be able to make ends meet, it also means more interest. That means you’ll be paying more overall.
Calculate The Monthly Payments
Lastly, you can use our online mortgage calculator to find out your potential monthly payments to the mortgage lender. While the monthly payment calculation is complex, you can still calculate the amount on your own by substituting the following formula:
Payment = P*((r(1+r)^ n)/((1+r)^ n-1))
P is the principal loan amount, r is the annual interest rate divided by 12, and n is the number of monthly payments you’ll make over the mortgage term.
Since this formula is rather complicated, for most people they are probably best sticking with online calculators!
Estimating How Much Mortgage You Can Pay
Now that you know how mortgages work, you should also know how the mortgage rate is decided. Here are all the factors affecting the rate that you could be offered by mortgage lenders:
Down-Payment
Lenders look at a couple of things when approving your mortgage. First, they assess the down payment — the amount you are able or willing to put up front as your deposit.
It’s only natural that the larger the down payment, the lower the mortgage payments, due to a decreased principal amount. The level of interest will also decrease, as this is impacted by the total amount of the mortgage loan.
Your Income
Next comes the risk part of the mortgage: your monthly income. Your disposable income determines your ability to pay the mortgage instalments. Typically, lenders are more reluctant to approve your mortgage if you don’t have sufficient disposable income to cover the monthly payments.
Fortunately, you can still get a mortgage if you have limited income. However, the lender will allocate a smaller percentage of your salary towards the mortgage repayments likely by extending the mortgage term as well as the secondary expenses.
The Property
The decision of a lender doesn’t just depend on your financial position, but it also relies on the property itself. Lenders might deny your application if they deem the property to be too expensive or risky. You can tip the odds in your favour, however, if you have an exceptional financial record and are willing to put down a substantial deposit, meaning you might get an approval.
Most lenders already have a directory of pre-approved property listings. If your property isn’t on the list, the lender might carry out a property valuation survey before granting you the loan.
Frequently Asked Questions
How can I lower my monthly mortgage payments?
It is possible to adjust a couple of aspects of your loan agreement to achieve lower monthly payments. These include:
- Extending the mortgage term
- Enhancing your credit score
- Improving your debt to income ratio
- Refinancing at a lower interest rate
Should I get a fixed or variable-interest-rate mortgage?
Each mortgage type has its benefits and drawbacks. If you value certainty and like to be prepared in advance, then paying extra for a fixed-interest rate mortgage might be worth it.
In contrast, variable-interest mortgages can give you a financial advantage, as the interest might drop in the middle of your mortgage term. However, there is also the possibility that interest rates might also go up or even skyrocket.
When should I expect to pay off my mortgage?
Nowadays, you can get short-term mortgages for as short as two or five years. But beware, the monthly payments could be astronomical. For this reason, more people than ever are opting for long-term mortgages with the average borrower expecting to pay off their loan by the time they reach retirement age of 65 years old (or 67 for younger lenders).
Percentage Of Your Income Mortgage Conclusions
Whether you’re getting a 5-year or 30-year loan, mortgage payments are usually monthly. Naturally, experts suggest making payments based on how much you can afford and that fit your monthly expenses and income so that you do not overextend yourself financially.
The rule of thumb is to put 36% of your salary towards debt settlement, with 28% going towards the home mortgage. More cautious individuals prefer to not overstep the 25% limit.
Alternatively, you might put 35% of your net income (post tax income) towards your mortgage. This means a shorter mortgage term, thus paying less interest and less in repayments overall. However, this would leave little room for savings and emergency funds each month.
If you are unsure of the percentage of your salary that you should put towards your mortgage repayments, speak to an expert mortgage broker. When The Bank Says No can advise you and ensure that any mortgage option we find for you provides you with the correct balance of value and affordability, regardless of your previous credit history.