How Big Should Your Mortgage Payment Be?

By Wendy Connick Markets Fool.com

IMAGE SOURCE: GETTY IMAGES.

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It's normal for rent or mortgage payments to be the biggest single monthly expenditure for a household. But if housing starts to take up too big a percentage of your available income, you'll find yourself strapped for cash.

Zillow's most recent housing affordability survey shows that housing expenditures are clearly on the rise, with typical monthly mortgage costs hitting 15.8% of median household income -- up from 14.7% a year before. While that's still low in historical terms, the upward trend, in combination with rising interest rates and home values, means that payments may soon be heading into the danger zone. Renters are paying even more percentage-wise, hitting 29.2% of median household income. And in certain metropolitan areas the housing expenditure numbers verge on gruesome: Los Angeles and San Francisco both sport mortgage expense percentages of more than 40% of median household income.

Most experts agree it's best to keep housing costs to less than 30% of income. Lenders will typically limit mortgage loans so that the monthly payment (including taxes and insurance) is no more than 28% of monthly household income.Of course, the highest monthly payment you can really afford may be a little higher or lower than that, depending on factors like your lifestyle and your other expenses.

So how can you figure out how big of a mortgage payment you can afford?

Start by taking a good look at your income and expenses

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Rather than depending on an arbitrary number like 28% or 30%, it's best to evaluate your household budget and see what percentage works for you. What you're looking for is a housing payment that you can pay every month without feeling stressed every time the due date rolls around. If you have a mortgage, you ideally want to be able to pay a little extra toward the principal every month, allowing you to get rid of the mortgage early and save on interest. If your gut reaction to that sentence was, "My mortgage payment is a pain already -- no way I can pay extra," then that's a sign you're paying more than you can afford.

Now take your monthly housing payment and divide it by your monthly household income. For example, if you pay $1,000 a month in rent, and your paychecks add up to $4,000 per month, then you divide $1,000 by $4,000 to get 0.25, or 25%. That number is your current housing payment percentage; remember it, because you'll use it to determine what the right percentage is for you.

Next, make a list of all your regular expenses. Don't forget the biggies that come around only once or twice a year, like insurance renewals. You can factor those large but sporadic expenses into your monthly budget by dividing the normal payment out over the number of months in the term. For example, if your car insurance renewal comes around once every six months, take the renewal amount and divide it by six to see how much it's costing you "per month." Once you have your expenses in front of you, ask yourself how comfortable you feel with your current situation. Do you have enough money every month to cover your expenses, plus a little to tuck away in savings? Do you live paycheck to paycheck, with creditors breathing down your neck until you can get a hold of the next chunk of income? Or worse, are you stuck with ever-growing credit card bills because you fall a little further behind every month? The answer will tell you whether your current housing costs are low, marginal, or too high compared to your current income and other expenses.

If you've already pared your non-housing expenses down as low as you can, yet you still have trouble paying all your expenses every month, then your housing payment is too high for your current situation. You might consider downsizing your home or possibly refinancing to get a smaller payment if you own your home.

If you're paying all the bills every month and can still stash a bit of money into savings and/or your retirement account every month, then your current housing payment is OK for your situation. Now is when you can go back to the percentage you calculated earlier and use that as a baseline.

If your current housing payment takes up 25% of your income and you're struggling to pay it, then you might aim for 20% or even 15% instead. On the other hand, if you're doing fine and have extra income every month, you could likely push the percentage up a little to 30% and still be all right.

Don't let the other costs of homeownership surprise you

If you're currently renting and are planning to buy a house using your rent payment as an affordability guideline, remember that as a homeowner you'll need to budget extra for maintenance and emergencies. If you buy a house and the furnace breaks down, or a pipe springs a leak and floods your kitchen, you can't just call the landlord and have him deal with it. You'll have to cover all these expenses yourself. Homeowners insurance will cover the cost of some crises, but you probably don't want to leave a foot of water on the kitchen floor until the insurance check arrives, so you'll need to have enough extra money kicking around to pay for repairs until you get reimbursed by the insurance company.

Whipping out a credit card for emergency housing expenditures is an option, but it's not a good one. Assuming you can't pay off the full amount of the card charge immediately, which is likely, you'll end up paying through the nose on interest and possibly fees. For that reason, you should prioritize setting up and funding an emergency savings account before you consider buying a house. Having enough money to cover at least a few months' worth of expenses is even more important for homeowners than it is for renters. And remember, making a down payment will inevitably take a huge chunk out of your savings, so take that into account when deciding if you have enough saved up to start house-hunting.

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