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. Calculating the cost of your current bills, council tax, what your mortgage repayments might be… it can certainly feel daunting at first.

The good news – there are tried and tested ways of calculating your ‘percentage mortgage income ‘.

Using these methods can help you check your affordability and creditworthiness. In addition, lender’s will conduct their own assessments on your financial standing and affordability to ensure that you’re financially able to secure the mortgage you need.

Your mortgage should never be an overwhelming financial burden, and although everyone is likely to have difficult months, the overall finance and terms of your mortgage should be manageable.

In this article, we explain everything you need to know about mortgage affordability, answering the question: “how much of your income should go to mortgage payments?” Let’s jump in.

What is a Mortgage Payment?

When you agree to take out a mortgage, you’re committing to repaying the full loan amount – plus interest – by the end of the agreed mortgage term. Depending on your chosen type of mortgage, this term (and by association monthly mortgage payments) could span 10, 15, or even 25 years.

This principle remains the same regardless of whether you choose a repayment or an interest-only mortgage.

The key difference is that with a repayment mortgage, you will repay the capital and interest each month. Whereas, on an interest-only mortgage, you will be required to repay only the interest – meaning the capital remains unpaid until the end of the term.

Most importantly, 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 four main components of your mortgage payment, including:

• Principal
• Interest
• Insurance
• Taxes

Let’s take a detailed look at each component and how it will affect your mortgage payments:

Principle

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

With a repayment mortgage, you gradually repay the loan by making monthly payments that include both interest and a portion of the capital. In the early years, most of your payment goes toward interest, with a smaller share reducing the capital.

As the mortgage progresses and the outstanding balance decreases, interest charges reduce – allowing a larger portion of your payment to go toward repaying the capital.

Interest Rates

The interest portion is effectively the charge a lender makes for providing you the loan.

The interest rate you obtain is dependent on variety of factors, including the Bank of England base rate, your initial deposit (loan-to-value percentage) and how much risk you represent to the mortgage provider.

Risk is calculated by your overall financial profile and your ability to reliable repay your debts. As such, if a lender deems you to be a low-risk borrower, you are much more likely to be able to secure a lower interest rate than that of a high-risk borrower.

Insurance

Insurance combines all of the policies you might want to take to in order to protect your new home and mortgage.

Since the bank/lender has a financial stake in the property until the mortgage is repaid, is it generally accepted that lenders will required you to have building insurance in order to protect their asset.

However, you can also opt into other protection insurances, including:

• Life insurance
• Critical illness cover
• Income protection insurance

Each insurance policy has its own benefits and can often provide peace of mind in the event of a tragedy. It is always best practice to ask a trusted mortgage broker – like Boon Brokers – what insurance policies would be available to you.

Tax

Most residential mortgages are unaffected by tax, but for landlords, mortgage interest may qualify for tax relief, typically reclaimed as a tax credit under current legislation.

When purchasing property, you may also be liable for Stamp Duty Land Tax, which must be paid upon completion. These funds are usually transferred to your solicitor, who submits the payment on your behalf.

To cover the cost of Stamp Duty, some buyers choose to increase their mortgage borrowing rather than using savings. While this can ease short-term cashflow, it increases the total loan amount, and therefore the interest payable over the mortgage term.

Where possible, it’s usually more cost-effective to pay Stamp Duty and associated fees upfront. Adding them to your mortgage may seem convenient, but the long-term cost of interest on that additional borrowing often outweighs the benefit.

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 do not financially need to worry about the monthly mortgage payments.

In reality, however, most buyers opt to buy properties closer to their affordability calculation – commonly known as living to your means.

If you choose to borrow near the top end of your affordability range, it’s important to understand that your monthly mortgage payments may become harder to manage – particularly if interest rates rise, as they have during recent periods of economic downturn and inflation.

28% Rule

The 28% rule is a pragmatic ‘rule of thumb’ whereby you keep your mortgage payment down to under 28% of your net monthly income (after tax).

This should allow you to be able to budget effectively for other bills and potentially set some finance aside in savings.

If your lender doesn’t apply Early Repayment Charges, making regular mortgage overpayments can be a major advantage – allowing you to reduce the loan balance faster and significantly cut down the total interest paid over time.

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
• The amount you can reasonably borrow

You should aim to secure the lowest interest rate for your circumstances when taking a mortgage or remortgaging. In addition, it is always best to take note and remortgage before your deal term ends, avoiding the move to 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.