Do the Old Rules Still Apply? Here’s How Much You Should Spend on Your Mortgage Each Month | Mortgages

It’s not uncommon for housing to be the typical American’s largest monthly expense. To keep it manageable, the general convention has long been to limit housing costs to 30% of pre-tax income. But based on today’s home prices, that’s a tall order.

Realtor.com puts the median home price at $419,250 as of September. A 20% down payment results in a loan worth $335,400. At a 7.5% rate, that results in a monthly payment of $2,345 for principal and interest.

But median weekly earnings for full-time wage and salary workers, as reported by the Bureau of Labor Statistics, were only $1,251 in the second quarter of the year. Assuming 52 weeks of pay, that’s an annual income of $65,052.

If we take 12 mortgage payments of $2,345 and apply the total, $28,140, to an annual income of $65,052, it puts those loan payments at roughly 43%. And that doesn’t include property taxes, insurance and other housing expenses.

All of this begs the question: Is keeping housing costs to 30% of income a reasonable benchmark given today’s home prices and mortgage rates? And what’s the risk of going over?

The rule of limiting housing costs to 30% of income may seem arbitrary, but there’s a reason financial experts have long upheld it.

As Michael Young, director of home lending at Wealthfront, explains, the guidance to spend no more than 30% of pre-tax income on housing actually originated in the late 1960s to protect low-income renters in public housing by capping rent at 25% of a tenant’s income. Congress later raised the cap to 30% in 1981.

But over the past few decades, housing costs have risen faster than household income. As such, that 30% guideline has been harder to stick to.

That’s why Young says the amount of your income you spend on housing may come down to what you want to prioritize, up to a point.

“Some people value or need to have a bigger home or closer commute,” he explains. “If you have no other debts, a lender will generally preapprove you for monthly payments that comprise up to 43% of your pre-tax income. But it’s up to you to decide if you feel comfortable handling the monthly payment.”

Andy Esser, financial advisor at Edward Jones, agrees.

“I think people get into trouble when they fixate on a single percentage,” he says. “Housing markets aren’t uniform, and neither are household budgets. Instead of asking whether a mortgage payment fits into a traditional guideline, I encourage people to look at what the payment leaves them with. After housing is covered, can you still save for retirement? Can you build emergency savings? Those answers tend to tell me more than any rule of thumb.”

Mike Dunlop, cofounder and partner at Ignite Financial, however, disagrees.

“I am going to push back and say that the convention still holds true, and that the 30% is not broken just because prices are higher,” he says. “Allocating a greater percentage of the monthly budget to housing forces cuts elsewhere. That’s food, transportation, health care, a properly funded emergency fund, retirement savings, entertainment, etc.”

Dunlop says that before committing a larger percentage of your income to housing, you may want to shift your search. That could mean resetting expectations on home size or considering a different ZIP code.

If you’re going to spend more than 30% of your income on housing, you’ll probably have to give something up in exchange. Young says the decision boils down to what you value most.

“For example, if you work from home and spend the vast majority of your time enjoying your space, it can make total sense to allocate more of your (income) toward housing and choose to be more frugal in other areas of your lifestyle,” he says.

Esser, meanwhile, feels strongly that a larger mortgage payment can work if it’s part of an intentional plan.

“The percentage itself doesn’t concern me nearly as much as whether the homeowner still has flexibility,” he says. “I want clients to be able to save for the future while also having room in the budget for the things that give their lives meaning today, whether that’s travel, hobbies, family experiences or causes they care about.”

Dunlop, however, cautions, “When housing costs are higher, so are all of the other costs.” In his experience, people who stretch their budgets for a more expensive housing payment inevitably also end up spending more on transportation costs and other things.

Plus, as he points out, a more expensive home likely comes with higher property taxes, insurance and maintenance costs. It’s easier than expected to end up house poor, even if you think you’ll be able to keep your nonmortgage expenses to a minimum.

Not only might larger mortgage payments squeeze your budget, but they could compromise your long-term financial security, Esser warns.

“For many households, the biggest consequence is what gets pushed aside to make that mortgage payment every month,” he says. “Retirement contributions often get reduced. Emergency savings take longer to build. Other goals get put on hold.”

Esser also says many people underestimate the value of financial breathing room.

“When too much income is committed to housing, everyday financial decisions become more constrained. Rising health care costs, a career transition, helping a family member or an unexpected expense can all require trade-offs that might not exist with a less burdensome mortgage payment,” he says.

All told, Esser believes in paying yourself first.

“If the mortgage becomes so large that you’re paying the house first,” he says, “and hoping there’s enough left over for retirement, savings and the life you want to live, that’s usually a sign the balance has shifted too far in the wrong direction.”