How much can I afford in mortgage payments?
We are all familiar with what a mortgage is, but do we know how much we can afford, by that I don’t mean how much the lender will lend me, but how much can I afford to pay each month?
A mortgage is a long-term loan, secured against a property. It’s secured lending which means if you default (miss a number of payments) the lender can reprocess your property in an attempt to recover their money. In contracts with unsecured lending, where this is not the case, due to the security, we expect to pay a lower rate of interest for the debt.
Irrespective that it’s less expensive, we want to ensure that we can afford the monthly mortgage payments both now and into the future, and I don’t recommend you forgo things that are important to you such as club membership and socialising to buy the house, long term missing out on these things that are important to you are likely to make you feel unhappy and resentment for the property you live in, when it is no longer exciting, shiny and new!
So how do you decide on how much you should borrow?
The MoneyAdvice Service has a good calculator to let you see based on your income, how much monthly payments would cost and when added to other living expenses, how this will affect your overall take home pay. You can find it here;
But that still does not give you a figure to aim towards, and I think because we are all different, we decide to spend our income on different things, it can easily be misleading for people.
As a quick estimate, £20,000 of mortgage over 25 years will cost you about £100pm. So, a £200,000 mortgage (not property!) will cost you about £1000pm, obviously interest rates will dictate the actual cost over this term.
There is a ‘general rule’ which is used to guide you with what size payment you should take on, but as with all general rules, including the 12.5% of income for investment, it’s just that a general rule, be intelligent with it when deciding on your own mortgage.
The 28/36 Rule
It’s called the 28/36 rule which measures borrowers’ ability to afford their mortgage payments based on their households’ gross monthly income, monthly housing-related payments, and all other monthly debt payments.
The 28/36 rule states that a household should spend no more than 28% of its gross monthly income on total housing expenses; which I call MIC (mortgage, insurances and council tax), and no more than 36% on all debt, including housing-related expenses and other recurring debt service; which I call MICOD (mortgage, insurances, council tax and ongoing debt)
Let’s start with MIC, the first half of the rule, which is that a household should spend no more than 28% of its gross monthly income on housing expenses.
- Housing expenses are generally summarised as MIC: mortgage payments, insurances and council tax. You would also include in here any rental payments (shared ownership properties), ground rent or service fee payments due. You do not include other housing expenses like utility bills or TV packages.
- If you expect to pay £850 in monthly mortgage payments, plus £30 in buildings and contents insurance and £90 for life assurance plus £150 in council tax, your MIC costs would be £1,120 per month. Thus, the household must have a gross monthly income (pre-tax income) of at least £4,000 per month (£1,120 / 28% = £4000) to meet this rule, this is equivalent of a couple earning £24,000pa each.
The second half of the rule, called the 36% rule, is calculated by dividing all recurring monthly payments on debt by a household’s gross monthly income. The 36% rule includes MIC plus all credit cards, car loans, student loans, and other personal loans. Where applicable, it also includes required monthly child support and other committed expenditure such as spousal support payments if they are expected to last for 12 months or more.
- For example: A car loan with 24 remaining monthly payments would be included, but a car loan with only nine payments remaining would not be.
- However, I always recommend buying a house with no unsecured debt, so you’re in the strongest position possible when you move in, so first work on building your emergency reserve of 3-12 months expenditure, repay all unsecured debt, then look to buy a property on strong foundations.
- The borrower with £1,120 MIC payments might also have a £200 monthly car payment, and a £120 credit card payment so MICOD (mortgage, insurances, council tax and ongoing debt) totalling £1,440pm, would need an income of £4,000pm (£1,449 / 36% = £4,000) in gross monthly income.
- With these payments at 36% it then leaves approximately 20% for tax and national insurance (actual will be nearer 17%), 12.5% for long term investment and approximately 30% for living.
A couple buying a house, each with £24,000 of annual income would produce the £4,000pm gross income. This would enable them to borrow £180,000 (3.75 income multiples) with a 10% or £20,000 deposit they could buy a property of £200,000 (approximate average UK property price); depending on where in the country you are, this may be a room!
The payments on a £180,000 mortgage would be over 25 years, £853pm, but remember to consider repaying over a shorter term, 20 years would be £998pm, but will save you £16,487 (£256,074 verse £239,586). You will need to work 10 months to earn this on £24,000pa! Do you want to work another 10 months for nothing?
A couple earning £24,000pa each will have a take home pay of £1,654pm each. Then deduct 12.5% for savings or £250pm each and the combined MICOD (although I’d rather you repay unsecured debt before moving in) of £1,449 leaves £1,359pm.
Allow £300pm on food and groceries, £200pm on transport, £400pm on WAM (£50 each per week), Gas and Electric £80pm, water £25pm leaves £354pm for capital expenditure, gifts and holidays.
As a side note, saving £250pm for 45 years is going to create c. £1.8m, that’s how you create wealth, by being intentional about it and using time as your friend in the stock market.
Now I know these are on paper, every one of the 1,000+ expenditure sheet’s I’ve seen in my life are different, so don’t shoot the messenger.
The biggest challenge to meeting this is firstly deciding that’s how you’re going to live and have a strategy to do it i.e. The Bank Account System.
I’d love to hear your views on these ratios, are they reasonable?