Here’s one important step to take before you start a home search.
What is a housing expense ratio?
A housing expense ratio is the comparison of a borrower’s before-tax income. The number often is calculated when lenders are deciding whether an individual qualifies for a mortgage.
When a lender is making a decision about offering a mortgage loan to an individual, he or she wants to know that the individual makes enough money to pay it back without struggling to pay for other expenses.
For this reason, the lender will measure the person’s income before taxes against housing expenses to find out how much risk is involved. Typical housing expenses include the principal, interest, property taxes, insurance and HOA fees.
Most lenders will not approve a loan if the number is higher than 28 percent. Exceptions may be made if the individual applies with a co-borrower or has an exceptional credit rate. Housing expense ratio also is referred to as front ratio.
Housing expense ratio example
Many lenders suggest finding out what your housing expense ratio is before applying for a mortgage. It is easy to do with a simple formula.
- Step 1: Add up how much your housing expenses are expected to be each month. Make sure you include the principal and interest on the mortgage, property taxes, house insurance, and association or condominium fees that you may pay.
- Step 2: Calculate the total gross salary you receive each month. This may include income from a job or your own business, bonuses, overtime pay, alimony and child support.
- Step 3: Divide the housing expenses by your monthly income. For example, if your housing expenses are $1,000 each month, but you make $5,000 per month, you would divide $1,000/$5,000. The answer is 0.2.
- Step 4: Multiple your answer by 100 to get 0.2 x 110 = 20. Because 20 is lower than 28, your lender is likely to give you a loan for the home in question.
If you are thinking about applying for a mortgage, use our mortgage calculator to estimate just how much your monthly payments will be.