ratios, back ratios and gross income
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
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
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.
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