How to calculate a mortgage payment within your budget

(NewsNation) — Homeownership feels out of reach for many Americans, but an anticipated interest rate cut this month could encourage a slow return to the market.

For those who already have a monthly mortgage payment, it’s unlikely their savings will be immediate. However, homeowners may feel longer-term benefits if mortgage rates continue to trend downward, according to the personal finance outlet Money.

Meanwhile, Americans owe $12.14 trillion on their homes, and mortgage debt accounts for 70.2% of consumer debt in the United States, according to Lending Tree.

A typical monthly mortgage payment rose to more than $2,000 last year, up from $1,000 three years ago, according to Lawrence Yun, chief economist at the National Association of Realtors.

“This doubling in housing costs for recent home buyers is not included in the official consumer price index inflation calculations and contributes to the sense of dissatisfaction about the economy,” Yun said in a statement.

How to calculate a mortgage payment within your budget

Mortgage affordability is calculated using a person’s gross or after-tax income and how much they owe for monthly expenses, otherwise known as the debt-to-income ratio.

The 28% rule, the 35/45 model and the 25% rule are common ways of calculating how much a person can afford to pay toward their mortgage each month, according to Chase Bank.

Under the first rule, a homeowner would aim to spend 28% or less of their monthly gross income on their mortgage payment.

The 35/45 model suggests that a person’s total monthly debt, including their mortgage payment, shouldn’t be more than 35% of their pretax income or 45% more than they make after taxes. That means if they multiply their gross income by 35% and tax-deducted income by 45%, their budget would be the range between those numbers.

Alternatively, a stricter 25% post-tax model says a person’s total monthly debt should be 25% or less of what they bring home after taxes. This model may be best for someone worried about overspending, according to a Yahoo! Finance report.

Sites like NerdWallet offer affordability calculators based on a person’s location, income, expenses and budgeting preferences.

Lenders typically do that math for applicants in addition to evaluating their credit scores.

How to keep mortgage payments low

Borrowers can keep their monthly mortgage payments down by increasing their credit score, extending their mortgage term and getting rid of private mortgage insurance by saving for a 20% down payment.

A high down payment may also mean borrowing less over time and cutting back on monthly payments.

"Down payments have always been important, but even more so today,” Zillow's chief economist Skylar Olsen said in a June news release. “With so few available, buyers may have to wait even longer for the right home to hit the market, especially now that buyers can afford less. Mortgage rate movements during that time could make the difference between affording that home and not.”

For someone with good credit, refinancing after an interest rate cut can also keep costs down.

How has homeownership affordability changed?

Buying a house in the U.S. today is less affordable than at any other time in the last 17 years, according to the real estate data company ATTOM.

Typical home costs, including mortgage payments, property insurance and taxes, consumed 35.1% of the average wage in the second quarter, according to ATTOM. That’s the highest share since 2007 — up from 32.1% last year. 

A June Zillow report noted that middle-class Americans would need to put down more than $127,000 to afford a monthly mortgage payment.

The typical home was worth about 50% less five years ago, and many homes would have been affordable to those same Americans with no money down, according to Zillow.

A possible cut to the Federal Reserve's benchmark interest rate this month could make homeownership feel more achievable for some, but others may continue to struggle.  

“Not only has the market already priced in a 25 basis point cut at the Fed’s September meeting, but also 25 basis point cuts each in the November and December meetings,” Ralph McLaughlin, senior economist at Realtor.com, told Forbes Advisor, referring to the measure of percentage change. “As such, we shouldn’t expect the downward movement in mortgage rates to accelerate unless worse-than-expected economic indicators suggest the market is headed for anything but a soft landing.”