When you start searching for your dream home, it can be fun to fantasize about buying one of the largest and most extravagant properties in your area. However, your income is likely to dictate the size and lavishness of the home you choose. When you apply for a home loan, the mortgage lender will analyze your assets, liabilities and income to determine if you have the ability to pay off the loan. More specifically, they will look at your discretionary income.
Understanding Your Income
To understand discretionary income, you must first understand how your income works. When you get paid by your employer, the amount of salary or wages you earn before any deductions are taken is your gross income. The money you have left over from your gross income each month after taking out taxes and paying for necessities is called discretionary income.
Discretionary income is derived from your disposable income, or your gross income minus taxes, and should not be confused. You can calculate your discretionary income by subtracting your disposable income and living expenses like:
- Mortgage payments
- Student loan payments
- Car payments
Discretionary Income & Your Home Loan
Discretionary income is generally what lenders are going to pay attention to since it is the money that borrowers will save or invest towards a down payment for a home. Although you may be approved for a large loan, it’s best to stay under budget. Purchasing a home you can truly afford without struggling will allow you to be a more stable homeowner. In general, your monthly mortgage payment should not exceed 28% of your gross income. You can refinance down the road to reduce your payment or the length of the loan.
There is not an actual rule for the amount of discretionary income someone should have. However, it was always better to have as much as possible so you can set aside as much as you can for emergencies. You can increase your discretionary income by reducing the amount of basic expenses or increasing gross earnings within your household.