Ready to get out of your current ‘less-than-ideal’ renting situation and buy your own home? If you shouted ‘yes!’ before you finished reading that sentence, it’s time to start thinking about your mortgage. How much will you need to spend each month, and how much of your income will off this massive purchase?
Check out our guide below to find out what percentage of your income should go to your mortgage.
What Percent of Income Should Go to Your Mortgage Table of Contents
What is the Minimum Income to Get a Mortgage?
This is kind of like asking, ‘how long is a piece of string.’ That’s because every mortgage is for a different amount, and so they all require a different minimum income. So, someone looking to borrow £40,000 can have a much lower income than someone looking to borrow £1 million (must be nice…).
Typically, banks and other lenders will give you a mortgage of 4.5 times the amount of your annual income. You can combine your income with another person’s earnings.
For example, if you earn £30,000, you could usually borrow a maximum amount of £135,000. You can also work this calculation backwards. So, if you want to borrow £200,000, you’ll usually need a minimum annual income of £44,500. There are a few professions who can sometimes borrow 5.5 times their annual salary (or even up to 7 times). These include dentists, doctors, and lawyers.
Lenders will also look at your other forms of income, including money earned from rental properties, pension income, child maintenance payments, and any earnings from your side hustles. So, you might want to start driving for Uber or delivering pizzas in your free time – you could boost your income enough to borrow more for your new home.
They’ll also want to check out your monthly spending patterns. For instance, how much do you pay for bills and splash out on entertainment and travel? They want to see how much you can afford to pay back every month. You could have a high income, but if you spend like crazy and have a high cost of living, they’ll worry you can’t pay them back.
And don’t forget about the ‘free’ money that you can get towards a down payment on your first home. You read that right – with a LISA (Lifetime ISA), the government will give you up to £1000 per year for free! If you save £4000, they’ll match 25%. The only stipulation is that you use it to buy your first home. If not, you lose the free money, which would be a real shame. This is one of the smartest tips for anyone buying their first house.
What Percentage of Income Should Go to a Mortgage?
There is no ‘one correct percentage’ of income you should be spending on your mortgage payments every month. Different people have different spending patterns and feel comfortable with a higher percentage going to their bills.
That said, most experts agree that if you spend more than 50% of your income on your debts (including your mortgage) you could start drowning and struggle to make your payments. When it comes to your mortgage payment, you’ll often see the figure “28% of your gross income” (the money you earn before taxes are taken off).
That means you shouldn’t be spending more than 28% of your monthly income on your mortgage payment. So, according to this advice, if you earn £2500 per month, your mortgage payment and mortgage insurance should be no more than £700.
Lenders often use the 28/36 rule to calculate your debt-to-income ratio (DTI). First, they look at the 28% rule described above, and then calculate your debt load (including your proposed mortgage payments), which should be no more than 36% of your income.
So, let’s put it this way: If 12% of your current income goes to paying down debt (such as credit cards, student loans, and financing agreements) and you were to add a mortgage payment of 28% of your income, you’d be at 40%. This puts you 4% over the 36% ‘rule.’ Therefore, they’ll usually only be willing to lend you money that only requires up to 24% of your monthly income.
Again, this is just a general rule – different lenders have different policies, and you might also have unique circumstances that allow you to borrow more.
Different Types of Mortgages
There are many different types of mortgages available in the UK – it can start to do your head in.
Here are some of the most common mortgages for people buying a new home.
Almost all mortgages are repayment mortgages, so we thought we’d start here. With a repayment mortgage, you pay back the principal amount you’ve borrowed plus additional interest. Over time, you build up equity in your home, and you own it outright at the end of the agreement.
Interest-only mortgages (the only non-repayment mortgage we’re covering today) requires that you pay back the interest accrued but not the principal (the actual cost of the home). You have to back the entire loan amount at the end of the agreement period, so you need to consistently set the payments aside.
Just remember, the interest doesn’t decrease as the principal goes down, as it would with a repayment loan, because you’re not paying the principal. That means you’ll pay a lot more overall.
Fixed-rate mortgages have a fixed interest rate for a set period and aren’t affected by Bank of England base rate rises or when the market changes. You’re locked into an intro rate for between 2 and 5 years.
Your monthly payments will be the same each month, but if the interest rate decreases, you won’t be able to take advantage without paying hefty penalties. However, you’ll also be spared rate increases. Most people choose to remortgage to get another good deal when the term is up.
Unlike a fixed-rate mortgage, the interest percentage on a variable rate mortgage can change at any time. Yes, it can drop, but it can also increase overnight – nothing is locked in with your lender, and you’re at the mercy of the Bank of England and the market. There are a few different variable-rate mortgages available – standard variable rate, tracker, discount, and capped rate, all of which could fluctuate at any time.
What are Help to Buy mortgages?
The Help to Buy scheme aims to help young people become homeowners in three ways: Help to Buy ISA, Help to Buy Equity Loan, and Help to Buy Shared Ownership.
- Help to Buy ISA – The government will match 25% of your savings for the deposit on your first home.
- Help to Buy Equity Loan – If you’re falling short on your deposit, you can seek a Help to Buy Equity Loan, which allows you to borrow 20% of the home’s value. You can then secure a 75% mortgage, meaning you only need to save 5%.
- Help to Buy Shared Ownership – If you can’t afford to (or don’t want to) own 100% of a home, you can instead buy a share of the property between 25% and 75%. You then pay market rent on the remaining percentage.
How Does My Credit Score Impact the Percentage of Income That Should Go to a Mortgage?
All lenders will take a long, hard look at your credit score before they agree to lend you the money for your home. The higher your credit score, the lower your interest and the better your terms. On the other hand, if you have a poor credit score, your interest will be higher and your terms? Not so great.
So, now’s the time to examine your credit score and do everything in your power to increase it before you make your application. That said, if you’re not able to get your score up much higher, you need to prepare to pay more of your income to your mortgage each month.
Is it Worth Paying off my Mortgage Early?
Some people just don’t like carrying debt, and so they want to pay off their mortgage as early as possible. If you can pay off your mortgage early, you might be able to afford another property, more holidays, and financial peace of mind.
Making extra payments seems like a good idea because if you pay down your mortgage sooner, you’ll pay a lot less interest over the years. For example, imagine you have £150,000 left on your 5% 25-year mortgage. If you could whack an additional £5000 lump sum on the mortgage, you’d save more than £11,500 in interest, and you’d be mortgage-free almost two years earlier.
Sounds great, right? But there are some important factors to consider before you go ahead. Your mortgage contract may not allow early repayment or may charge extra fees and penalties if you make additional payments. Look into your terms before going ahead.
You should also think about the following:
- Do you have higher interest debts?
If you have any other debt, such as catalogue accounts and credit cards, they’re charging much higher interest than the interest on your mortgage. You should always pay these debts off before making extra mortgage payments.
- Are you paying into a pension?
While your home gives you some measure of security in your retirement years, it’s no substitute for contributing to your pension scheme. The earlier you begin to save, the more your interest will mount up and the better off you’ll be in your old age.
- Do you have an emergency fund?
If something happened to you or someone in your family, would you be financially secure? Could you afford an unexpected cost or take an extended period off work to cope with an emergency or an illness and still pay your household costs? If the answer is no, putting together an emergency fund of six months’ living expenses should be your top priority.
- Can you get a better return on investment elsewhere?
Finally, could you save your money in an account or ISA with a higher yield than the interest you’re paying on your mortgage? If your mortgage interest is 3%, but you can find a savings account that pays you 3.5%, stick with the savings. You’ll do better in the long run.
Do you know someone who is planning to buy a new home and seeking a mortgage? Share this article and do them a solid.