Ratios dictate home mortgage fate

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Dear 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

Dear 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.

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