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The Ultimate Guide To Housing Expense Ratio One Must Know

 

Introduction

When individuals are planning to buy a new home with the help of a mortgage, many get confused on what is the home value that they can afford and how much is the loan amount that they can qualify for.

When you apply for a mortgage, your lender will be able to let you know the maximum loan amount that you can qualify for.

For qualification purposes, they use the term known as housing expense ratio or housing ratio, and debt to income ratio. In this post, we will learn what is housing ratio, and how to calculate it.

What Is The Housing Expense Ratio?

A housing ratio is a ratio where the borrower’s gross income is compared to the housing expense like mortgage payments, taxes, insurance, homeowner’s association fees, etc. every month.

It is one of the qualifying parameters for the lender to decide if an individual is qualifying for a specific amount of loan.

This is also known as the front-end ratio. It is a percentage calculated to understand how much of the borrower’s income is going towards the housing expense.

How To Calculate Housing Expense Ratio?

To calculate the housing ratio, you have to consider your before-tax income and divide it by the total housing expenses.

The lender’s underwriter will use the same formula to understand if you qualify for the amount of mortgage that you have applied for. Let’s take an example to calculate the housing ratio.

Firstly, you need to add all your housing expenses. Let’s say your potential mortgage payment including the principal, interest, property taxes, and homeowner’s insurance is $1250 each month.

Your homeowner Association fees are $150 every month. Added together your housing expense comes to $1350.

Now you need to calculate your before-tax monthly income from your paystubs. Let’s say you get paid the rate of $25.90 per hour.

The minimum hours that you work in a week are 40 hours. This means your per week income would be 35.90 X 40 which equals $1,436.

Then your annual income would be 1436*52 which is equal to $74,672. To get the monthly income we will divide $74,672 by 12 which equals $6222.66 every month.

Now to know your housing expense ratio, we will now divide your total monthly housing expense amount ($1,350) by your gross monthly income ($6222.66) which equals 0.22 or 22% after converting it to percentage.

This means 22% of your gross income will go towards your housing expense.

To easily qualify for a mortgage your housing ratio should be less than 28%. This threshold is considered by most lenders to determine if you qualify for a specific loan amount.

In our above example, the housing expense ratio is below the threshold which means the borrower will qualify for the amount of loan he/she has applied for.

If the ratio goes above 28%, you can either add a co-borrower or look for a home for a lesser amount. Adding a co-borrower will lower the housing ratio.

Other Things To Consider About Housing Ratio

While qualifying a borrower, the lender will consider a 28/36 rule. In this rule they expect the housing ratio or the front-end ratio to be close to 28%, and the Debt-to-income ratio or the back-end ratio to be close to 36%.

DTI is the percentage of your gross income to your debts like car loans, credit cards, student loans, personal loans, etc. including your housing expenses.

If your front-end and back-end ratios are over the threshold, it is difficult to qualify for a conventional mortgage. However, there are loan programs available where you still might be able to qualify, but these options may have higher interest rates or added costs.

Conclusion

Buying a new home is going to be one of the biggest financial decisions of your life. You need to ensure that you make the right decision while finalizing the home that you are planning to buy as buying an over-budget home can bring a lot of financial challenges.

If you are thinking of buying a new home, you can use this ratio to calculate your home affordability so that you can buy a home that best fits your budget and also qualify for the mortgage at the same time.

https://www.compareclosing.com/blog/what-is-a-housing-expense-ratio/

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