A Guide To The Housing Expense Ratio
Andrew Dehan3-minute read
July 21, 2023
Your housing expense ratio, also known as the house-to-income or housing ratio, is a useful indicator to see how much you can afford on a house. Your lender will use it while underwriting your mortgage. This handy guide will lay out what a housing expense ratio is, how to calculate it and what it means for you.
What Is The Housing Ratio?
The housing expense ratio, also called the front-end ratio, is a percentage determined by dividing the borrower’s housing expenses by their gross income. At its most basic, it’s a simple number showing how much of your income goes to paying for housing, and considers your mortgage payment, insurance, taxes and more. Mortgage lenders use this ratio to help determine whether a home buyer qualifies for a mortgage loan.
Lenders frequently use the housing expense ratio in conjunction with the debt-to-income ratio (DTI). Your DTI incorporates your housing expense and your additional debt obligations, such as car and student loans, to determine how much of your monthly income is committed to your total debt obligations. DTI helps lenders see how much you spend on monthly debts versus how much money you have coming into your home.
Both of these formulas give lenders a better view of your financial situation beyond your credit score or debt payment history.
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How To Calculate Your Housing Expense Ratio
To calculate your housing expense ratio, take your gross monthly income and weigh it against housing expenses. This formula is what mortgage lenders do to determine the risk involved with a loan and is officially performed by an underwriter.
Let’s break down the calculation for you step-by-step. We’ll walk it through with an example so you can see how it fits together.
1. Add Together All Housing Expenses
To determine your housing expense ratio, a mortgage underwriter adds together all your housing-related costs. For the first step of our example, we’ll use a loan amount of $250,000 for 30 years at a 3.2% interest rate. The taxes, homeowners association (HOA) fees, homeowners insurance and private mortgage insurance used are based on national averages.
- Principal and interest mortgage payment: $1,081.17
- Estimated property taxes: $250
- Homeowners insurance: $136
- Mortgage insurance: $208.33
- Housing association fees: $250
Added together, this brings the total monthly housing expense to $1,925.50.
2. Divide By Gross Income
The next step is to compare your expenses to your pretax income. For this example, we’ll use the median family gross income (annual pretax earnings) of $86,011. That breaks down to $7,167.58 monthly.
To determine our housing expense ratio, we’ll divide our expense ($1,925.50) by our income ($7,167.58). Rounded up, our result is 0.27. This number means that 27% of our pretax income goes to housing costs.
3. Evaluate The Results
The final step is to work together with a lender to assess whether 27% will work for you as the potential borrower. It’s an important number to determine if you can or can’t afford a home. Mortgage lenders want to make sure you have affordable housing, so if your income isn’t high enough to make the loan payments, you won’t be approved.
If you find yourself in this situation, you can consider ways to reduce your expense ratio or look for lower housing prices and smaller monthly payments. In other words, you can make a bigger down payment, find a more affordable home or house hunt in an area without HOA fees or lower real estate taxes.
What Is The 28/36 Rule, And How Does It Affect Your Loan?
The 28/36 rule is more of a simple calculation that can help you determine how mortgage you could comfortably afford. In the this rule, the “28” is your housing expense ratio, and the “36” is your DTI. When used together, the housing expense ratio is referred to as the “front-end ratio,” and the DTI ratio is referred to as the “back-end ratio.”
Where your housing expense ratio only includes housing expenses, your DTI factors in debt like car loans, student loans and credit cards. If over 36% of your income is being spent to pay off debt, you may have more difficulty getting a home loan. Paying down your debt to lower your DTI will help your chances of getting a mortgage.
Keep in mind that this is just a starting place and not a true “rule” when it comes to qualifying for a mortgage. To know exactly what you qualify for you should talk to a Home Loan Expert who can help assess your specific financial situation.
The Bottom Line
The housing expense ratio, or house-to-income ratio, is a quick way you and your lender can determine how much house you can afford. If you’re thinking about applying for a loan, you should calculate your housing expense ratio before you apply.
Want to find what purchase options you qualify for based on your housing expense and DTI ratio results? Start the mortgage process today to get your answers.
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