How Much of Your Income Should Go to Mortgage Payments?

Entering into a mortgage as a first-time buyer can be like stepping into the big unknown. For many people getting onto the property ladder, it can be daunting trying to calculate the cost of bills, council tax and mortgage payments.

The good news is there are tried and tested methods to check that a mortgage is affordable for you and lenders themselves conduct affordability calculations. Your mortgage should not be a significant financial burden and although everyone is likely to have tight months at some point during their mortgage, they should be manageable.

Let’s explore whether a mortgage is affordable and how much of your income should go to mortgage payments.

What is a Mortgage Payment?

When you borrow on a mortgage you are committing to repay that by the end of your mortgage term. This is the same regardless of whether you choose a repayment or an interest-only mortgage. The difference is you will repay the capital and interest each month on a repayment mortgage and only the interest on an interest-only mortgage.

At the end of an interest-only mortgage you will have a large capital amount outstanding which you will need to settle.

Failing to make a mortgage payment will count as a missed payment. Three missed mortgage payments are classified as a default and anything beyond this will expose you to repossession.

Components of a Mortgage Payment

There are two main components of your mortgage payment although you may have additional costs associated with your mortgage too.

Components of a Mortgage Payment

The principle is the capital you owe the lender. If you borrow £200,000 from a mortgage provider, you will owe the £200,000 irrespective of any interest they charge.

With repayment mortgages, you pay a portion of the capital back each month alongside your interest payment. Earlier in the mortgage the capital portion of your monthly payment is lower and as time goes by and you reduce the capital, the interest on the loan reduces.

Later in a mortgage, your capital portion will be higher, reflecting the fact you have paid down capital on the loan and the lower interest chargeable on the outstanding balance.

Interest

The interest portion is effectively the charge a lender makes for providing you the loan. The interest rate you obtain is dependent on various factors including the Bank of England base rate and how much risk you represent to the mortgage provider.

If you are low risk, you will find your interest rate is lower compared to a high-risk borrower.

Other Mortgage Payment Expenses

There is also other expenditure alongside your mortgage payment in most cases.

Insurance

Insurance is usually a combination of various policies you might want to take to protect your mortgage.

Lenders normally require you to have buildings insurance to cover the property you are buying. You may also opt to protect your mortgage balance in the event you pass away or get critically ill by taking Life Insurance and Critical Illness cover.

Another policy borrowers take is Income Protection, which is designed to cover monthly expenditures related to your mortgage if you are unable to work.

Tax

Most mortgages operate tax-free, or in a tax beneficial way as landlords are able to reclaim some tax as a tax credit.

Some property purchases are subject to Stamp Duty. This tax must be paid at completion stage. The funds are transferred to your solicitor. Some people choose to increase their mortgage borrowing accordingly to account for the stamp duty payment, which frees up their savings to use towards the tax. If you add the Stamp Duty funds or any fees to your loan you are increasing the amount you borrow and therefore the amount of interest, you will owe.

It is usually better to pay any fees and Stamp Duty upfront rather than add it to your loan. This is because the cost of paying interest over a mortgage term is often costly compared to the amount you are originally borrowed.

What Percentage of Your Income Should Go to Your Mortgage Payment?

There is no golden rule, or one size fits all solution to how much of your income should go towards your mortgage payment.

Typically, the advice is to buy a property you can easily afford and not worry about the monthly mortgage payments. In most cases, buyers opt to buy properties closer to their affordability calculation – commonly known as living to your means.

In the latter case, your mortgage payments may be more difficult to budget for, especially if mortgage interest rates change like they did recently due to the economic downturn and inflation.

28% Rule

Realistically, you want to keep your mortgage payment under 28% of your net monthly income (after tax).

Doing so allows you to budget effectively for other bills and also in most cases set aside money in savings.

If your lender has no Early Repayment Charges you may even opt to make overpayments on your mortgage to clear it down quicker.

35% to 45% Rule

In recent times, with property prices increasing significantly and wage growth unable to keep pace, advisers have adjusted their recommendation to keep mortgage payments between 35% and 45% of net income.

Providing this percentage falls within a lenders’ affordability check and you feel comfortable enough to afford your mortgage, there is nothing wrong with this recommendation.

Beware though, as if the economy changes such as the Cost-of-Living crisis, having a mortgage that was initially 45% of your net income can easily exceed 55%. When you factor in price increases across energy bills, council tax and groceries, this kind of swing in percentage can break your ability to keep up with your monthly mortgage payments.

Factors That Influence How Much You Put Toward the Mortgage Payment

There are three main factors that influence your mortgage payments. The interest rate you are able to secure when you take the mortgage, the value of the property you buy and therefore the amount you borrow, and wider market conditions.

You should aim to secure the lowest interest rate for your circumstances when taking a mortgage or remortgaging. You should aim to remortgage before your deal term ends to avoid the lender’s more expensive Standard Variable Rate.

When choosing a property, you should aim to borrow within your means and if possible, put a larger deposit down. In practice the more you can minimise your borrowing the less you expose yourself to financial risk.

Property owners should pay attention to politics and trends in the economy. Knowing which political parties have favourable policies for homeowners and how the economy might change as a result can help you plan ahead. The Bank of England base rate is largely affected by Government spending and borrowing, and in turn, a base rate change has a big impact on the rate your lender will offer you on your mortgage.

Speak to a Mortgage Broker

If you are concerned about whether you can afford a mortgage or simply want the best course of action for your situation, you should contact a mortgage broker.

Boon Brokers is a Whole of Market Mortgage, Insurance and Equity Release Brokerage. Boon Brokers provides fee free mortgage advice.

Contact Boon Brokers to book your no obligation mortgage consultation today.