What Is the Recommended Mortgage Payment

The monthly payment is the single biggest factor affecting your mortgage. The higher it is, the cheaper, shorter, and safer the mortgage. Pay less each month, and you'll stay with the mortgage longer, your maximum monthly payment will (probably) be higher, and the interest you pay the bank will balloon.

The trouble is, setting the monthly mortgage payment is the trickiest part of mortgage planning. It requires understanding your savings and expenses, forces you to anticipate future costs, and demands balancing constraints against savings. On top of that, the monthly payments on most loans depend on external variables beyond our control. So we also have to hedge our risks — to make sure a rising monthly payment doesn't push us into financial trouble down the road.

As if that weren't enough, for most of us the mortgage is the first major debt we'll take on in our lives. Beyond the financial burden, there's a psychological one — we have to live with the unsettling thought of owing money to an outside party. It's a binding contract we have to honor, whether we like it or not. So it's natural to want out of this debt as fast as possible.

Given all this, and the understanding that a higher monthly payment means a better mortgage, someone might use the following (in our opinion mistaken) rule of thumb to set their monthly payment.

In our opinion, this approach is wrong. It sacrifices savings on the altar of cheap debt and ignores the changing needs of the household. It puts too much weight on managing debt and too little on building assets and covering day-to-day expenses. Stay with us — we'll explain why.

Setting the mortgage payment — a balancing act

Our household calls for careful financial management. We need money for day-to-day expenses (municipal rates, tuition, food, transport, trips, etc.). We need money to meet our long-term obligations (the mortgage and other loans), and we need money to build up assets and investments.

Unfortunately, our monthly income is limited and the blanket is too short. Most of us don't earn 50,000 NIS a month, so our income simply isn't high enough to take a yearly trip to Thailand, save 100,000 NIS, and pay off the mortgage within ten years — all at once.

Given these constraints, trade-offs are unavoidable. We have to decide what to let slide and what to prioritize.

If we prioritize:

• Obligations: Our mortgage ends sooner. It's cheaper and safer.
• Assets: We build up a large asset portfolio to serve us in old age. We'll have plenty of money for emergencies.
• Day-to-day expenses: We can enjoy a higher standard of living for our family — more flights, more outings. We can invest more in our kids, and so on.

Every coin has two sides. Favoring one means giving up another. Now we want to tell you about some misguided (in our view) ways of dividing up the money.

Common behavioral patterns in setting the mortgage payment

After countless conversations with households, we've identified common patterns and rules of thumb people use to set their monthly mortgage payment. We'll focus on the ones we think are common but perhaps not quite right.

Childless and/or living with parents — and then choosing too high a monthly payment

As noted, it's tempting to commit to a high monthly payment: work hard now, month after month, to pay off the mortgage sooner. We made this mistake ourselves — we wanted to finish the mortgage before fifty, so we committed to a high payment relative to the debt we took on.

We felt comfortable with that payment because we figured our household was settled and complete, and we knew our monthly expense structure. We didn't expect it to change much, so we were confident we could balance obligations, assets, and day-to-day expenses.

That's not the case for someone who lives with their parents or doesn't yet have children. In both situations, you don't know your expense structure yet. You're dazzled by your high savings rate and have no idea what day-to-day life will actually cost. When you're not paying rent or household costs, it's very easy to adopt a lifestyle — and assume a savings rate — that won't be sustainable later.

With children, it gets even more complicated. We make decisions about housing, career, and lifestyle with our children's wellbeing in mind. Back when we were students, our monthly expenses were a seventh of what they are today, with three kids.

And it's not only about children — as you get older and earn more, it's natural to want to raise your standard of living, which translates into an expense structure different from the one you have now.

Wiping out the mortgage — at any cost

This pattern is similar to the one above, except that this time people genuinely know their expense structure. So what makes it different? This time they're knowingly sacrificing their savings to clear their debts. The monthly payment they plan leaves them breaking even each month, or with only a negligible sum on the side.

Daniel Kahneman and Amos Tversky defined Prospect Theory. It shows that a debt of one hundred thousand NIS makes us feel three times worse than savings of one hundred thousand NIS make us feel good. For that reason, and without any prior financial education, most of us tend to take every possible step to wipe out the mortgage debt — including dipping into the savings we've built up. Someone who behaves this way is risk-averse (risk averse behavior).

All these risk-averse people who decided to pay off the mortgage as fast as possible are ignoring the surprises life has in store. They forget that along the way they'll need money to replace their car (it won't last 20 years!), to fund the kids' dental treatment, to celebrate a bar/bat mitzvah, to replace the washing machine, and to handle every other problem they haven't thought of yet.

There's no reason to run yourself into the ground over it: no one will be waiting with a medal once your mortgage is paid off. Quite the opposite. Most people take out a mortgage when their family is just forming and the children are still young. You'll be paying it during the most critical period of your lives as a family. Your children are little and need you completely. This is your time to create the experiences and memories that will stay with you for years to come. By the time you finally finish the mortgage and want to start living, will your children still be around to share in your plans?

The right way to do it

First, you have to understand how much you spend each month. The right way to do this is by examining your day-to-day expenses over a long period, so you can work out your average (preferably median) monthly expense. Then try to forecast whether your expenses will grow in the future — due to changes in transport costs, health, a growing family, and so on.

After that, set the mortgage payment so that it balances all three corners of the triangle:

• Money for day-to-day expenses: regular costs, holidays, entertainment, and money for surprises.
• Money for savings: to allow a decent standard of living in retirement, to help your children when they grow up, and to keep money aside for a rainy day.
• Money for the monthly payment: for the mortgage and other loans.

To check how much the payment changes across different mortgage mixtures, try our mortgage calculator.

Good luck!