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How Much Should You Ideally Pay For Your Mortgage?

As mortgage rates continue to rise, it's important to evaluate how much mortgage you will be able to spare not just today but in the long run.
Cover Image Source: Pexels | RDNE Stock project
Cover Image Source: Pexels | RDNE Stock project

Editor's note: This article was originally published on July 14, 2023.

Buying a home is easier said than done. Even the smallest things need to be planned to buy a house without jeopardizing the finances. It's important to evaluate how much mortgage you will be able to spare not just today but in the long run. It's always a good idea to consult a financial advisor who will evaluate it for you after taking your needs and finances into consideration.

Mortgage rates have continued their upward trajectory in July, rising to the highest rate this year so far, stated Sam Khater, Chief Economist Freddie Mac on July 6, 2023. "This upward trend is being driven by a resilient economy, persistent inflation, and a more hawkish tone from the Federal Reserve," Khater added. As homebuying and refinancing by homeowners become challenging in such a scenario and American households suffer a total mortgage debt of $12.04 trillion in Q1 2023, per data reported by The Motley Fool, here are a few things you should know about mortgages.

Pexels | RDNE Stock project

Pexels | RDNE Stock project

 Debt To Income Ratio

It is normally calculated by the lender to evaluate if you will be able to cover the mortgage even after paying other loans like student loans, credit loans, debt loans, and car loans. After adding up all the monthly payments and the mortgage, they want it to be no more than 43% of your income. Say, you have a car loan of $500 per month and also owe $225 a month for a student loan and have a mortgage of $2000, then you would need more than $7000 monthly income to qualify for the loans.

30% Rule

You can also simply multiply your income by 30% and the number that you will get is how much you can afford to pay the mortgage every month. For example, if you make $2000 a month then, $2000 multiplied by 30%, which is $600 is the amount you can afford to pay as the mortgage. This technique is a little flawed as it doesn't take your other recurring payments into consideration.

Image Source: RDNE Stock project/Pexels
Image Source: RDNE Stock project/Pexels

Dividing The Income By 2 and a Half

If you divide your gross income by 2.5, you will get a slightly different number which can also be assumed as your mortgage payment. Say, you pay $2000 per month, then the calculation would be $2000 divided by 2.5 which makes the mortgage amount $800.

Most experts say that there are lesser financial benefits to paying off your mortgage early. Say, a woman named Rachel pays off her mortgage in 26 years and saves $22,590 in interest expenses. She could easily have invested the extra money for higher returns and used the returns to pay the mortgage and still have money left. By applying this, Rachel also risks getting her money stuck in equity jail. So to avoid this, you should set up an account where you can deposit the extra cash whenever you can. You can invest this money for higher returns or simply park it in a savings account.

Image Source: Teona Swift/Pexels
Image Source: Teona Swift/Pexels

The most common mortgages are for 30 years and 15 years. These are fixed-rate mortgages. There are also terms as short as half a decade. Stretching your payment will make the installments smaller but also increase the interest over time. Here are the most common types of mortgages.

Fixed Rate: In this case, the interest rate always remains fixed for the entire loan. This kind of mortgage is also called the traditional mortgage.

Adjustable Rate: ARM or the Adjustable Rate Mortgage is the kind where the interest is fixed for the initial term but will then periodically alter based on the interest rates.

Reverse Mortgages: In this case, homeowners who are 62 or older can convert a part of the equity on their homes into liquid wealth.