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Dr. Don Taylor, CFA, advice columnistFront ratios, back ratios and gross income

Dear Dr. Don,
When there are budgeting recommendations such as "your mortgage payment should fall between 25 percent and 35 percent of your income," is that gross or net income?
-- Mike Measurement

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Dear Mike,
Here's a rule of thumb that's grounded in practice. Mortgage lenders have a standard called the "front ratio" that measures your mortgage expense -- principal, interest, taxes and insurance, or PITI -- as a percentage of your gross monthly income. It's typical for lenders to require that the front ratio be no more than 28 percent.

The other important ratio is the back ratio. That includes your mortgage expense plus other contractual loan payments, such as car loans, student loans and credit card payments. Once again, it's expressed as a percentage of gross monthly income, not net. Lenders may be a little more flexible on the back ratio, but traditionally they've required that the back ratio not be more than 36 percent.

There are sound financial reasons not to be house-rich and cash-poor. As a rough standard, if 36 percent of your monthly income is going toward housing and other contractual payments, and let's say payroll, state and local taxes take 30 percent of your monthly income, that leaves only one-third of your gross monthly income to go toward current living expenses and investing for your future financial and life goals.

In some regions of the country strict adherence to the front and the back ratios in determining who qualifies for a mortgage loan would shut down mortgage lending in that market. Lenders out of necessity in these markets have loosened their requirements for these ratios, but low 30s for a front ratio and low 40s for a back ratio would be about as high as you could go in qualifying for a mortgage loan.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "financing a home," "saving & investing" or "money."'s corrections policy -- Posted: Nov. 29, 2006
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