mortgage

Ratios dictate home mortgage fate

Don Taylorq_v2.gifDear Dr. Don,
I am 39 years old and about to buy my first home. I am looking at a house that costs $250,000 and am planning to go for an FHA loan when selecting a home mortgage. According to my loan officer, the monthly payment is going to be $2,100, not including utilities. I bring home $4,200 a month. Is it wise to spend 50 percent of my monthly income toward a mortgage? In another words, can I afford it? Please advise at your earliest convenience.
-- Emba Evaluates

a_v2.gifDear Emba,
You're right to be concerned. Spending 50 percent of your monthly take-home pay on the home mortgage payment is a lot. However, in loan underwriting, lenders look at the so-called "front ratio," which considers gross income rather than take-home pay.

Bankrate's glossary defines the front ratio as follows:

"The percentage of monthly before-tax income that goes toward a house payment -- a key ratio that lenders use when deciding whether to approve a mortgage application. Traditionally, lenders didn't like it when the total mortgage payment (principal, interest, taxes and insurance) divided by gross monthly income exceeded 28 percent. Modern risk-based pricing, however, has made lenders more flexible."

That flexibility would certainly extend to a Federal Housing Administration loan, where front ratios of 31 percent are considered acceptable risks. The Housing and Urban Development portal has a link to a Ginnie Mae calculator, "How much home can you afford?" that shows how much house you can afford using FHA, Veterans Affairs or conventional financing.

The lender also computes a back ratio that considers all monthly debt payments -- including principal, interest, taxes and insurance (collectively known as "PITI") -- and divides it by the monthly gross income. FHA guidelines typically limit the back ratio to 43 percent of monthly gross income.

I'm a big proponent of financial flexibility. Being "house rich" and "cash poor" can severely cramp your lifestyle. Put together a monthly spending plan to see where the money goes. Bankrate's home budget calculator will let you lay it all out and show you whether you can afford the housing costs.

Bankrate's content, including the guidance of its advice-and-expert columns and this Web site, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this Web site is governed by Bankrate's Terms of Use.

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." Read more Dr. Don columns for additional personal finance advice.

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