While paying down your debt is an important long-term goal, debt payment should only make up a small portion of your total budget. Obviously, if it interferes with payments for other necessities, like utility bills or transportation to and from work, you'll just be digging yourself into a different hole. Financial advisers and lenders differ in their recommendations, and the right percentage also depends on what types of debt you have.
Net vs. Gross Pay
Your take-home pay is called net pay because it is what you actually get with each paycheck. Your gross pay, on the other hand, is the amount that your employer designates as your salary before subtracting taxes, voluntary retirement contributions, health insurance dues and income tax withholding. Many financial experts make recommendations based on gross pay, not take-home pay, so the percent of your take-home pay that you should spend on loan payments will vary depending on how much money comes out of your paycheck before you get it.
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Most lenders require that your mortgage payment, including taxes and insurance, be no more than 28 percent of your gross pay. To find the correct percentage for your take-home pay, divide your monthly gross pay by your take-home pay and multiply this by 28. For example, say your monthly gross salary is $4,000, but your monthly take-home pay is only $3,180. Divide $4,000/$3,180 to get 1.26 and multiply this by 28 to calculate that in this case, your mortgage payment should only be 35 percent of your net pay.
Lenders for mortgages typically do not want your total debt payments, including your mortgage, to exceed 36 percent of your gross pay. If your mortgage is the full 28 percent, this means that your other debt can be up to 8 percent of your gross pay. Use the same calculations as for the mortgage payment, substituting 8 for 28 to find how much of your net pay should go to other debts. If your mortgage is less than the maximum allowable for your income, you might be able to afford a slightly higher amount for other debts.
Department of Education
The Department of Education recommends limiting your debt payments, including student loans, credit cards and auto loans, to no more than 15 percent of your take-home pay. Note that this is more than the 8 percent or less of your gross pay that you are supposed to be spending on debt when you get a mortgage. Therefore, if your student loan payments are significant, you might have to pay off some of that debt before you can qualify for a mortgage.
Liz Pulliam Weston of MSN Money advocates a budgeting approach designed by Elizabeth Warren and Amelia Warren Tyagi. In this approach, the sum of all of your required payments should be no more than 50 percent of your take-home pay. These payments include not only minimum debt payments and rent, if you don't have a mortgage, but also utilities, insurance, food and basic transportation. In this scenario, because of necessary expenses besides debt, you should use no more than 30 to 40 percent of your take-home pay on minimum loan payments. Warren and Tyagi also recommend using about 20 percent of your take home pay either for savings or for making extra loan payments beyond the minimum.