When you apply for a loan, a lender normally looks at two debt-to-income ratios. One ratio is the housing expense ratio, commonly referred to as the front-end ratio. A second ratio lenders consider is your total debt-to-income ratio, or back-end ratio. Wells Fargo explains that debt ratios tell lenders whether you can afford to pay a mortgage. Although some lenders are more flexible in their requirements and allow for higher ratios, most tend to follow standard guidelines.
Housing Costs: Front-End Ratio
When you apply for a home loan, the housing expense debt-to-income ratio evaluates the amount of your gross monthly income you would spend on a mortgage payment. Along with the principal and interest you would pay on a mortgage loan each month, a lender will include real estate taxes, homeowners insurance, additional hazard insurance, and mortgage insurance premiums in your housing costs. Generally, the amount you pay toward housing should not be more than 28 percent of your monthly income before taxes, reports Bankrate. You can calculate an estimation of the maximum amount you are allowed for housing costs each month by multiplying your annual income by 28 percent and then dividing the total by 12 months.
Total Debt Obligations: Back-End Ratio
A lender also looks at your total debt-to-income ratio to see how much of your gross monthly income you use to pay on all of your debts. Your back-end ratio includes your mortgage expenses, any child support or alimony you pay, and consumer debts, including credit card bills, car loans and student loans. According to Bankrate, the total debt payments you make each month should not come to more than 36 percent of your gross monthly income. To get an estimate of the total debt payments you can make each month and not go over the maximum total debt-to-income ratio allowed, multiply your annual income by 36 percent and then divide that number by 12.
FHA Debt-to-Income Ratios
The Federal Housing Administration allows higher ratios than most conventional lenders. The maximum housing expense ratio you can have and still qualify for an FHA-insured home loan is 31 percent. The FHA also allows a maximum total debt-to-income ratio of 43 percent. To see if you fall within the required housing expense ratio, divide the amount of the mortgage payment you will have by your gross monthly income. Likewise, figure your overall debt-to-income ratio by dividing the total of your monthly debt payments -- including your housing expense -- by your pretax monthly income. If you are married, include your spouse’s income.
Considering More Than Debt Ratios
The debt-to-income ratios lenders find acceptable can vary depending on your credit rating and the size of the down payment you make. Although high ratios can get you denied, a total debt-to-income ratio below 20 percent improves your eligibility, and may get you more money and better loan terms, notes Zillow. Lenders rely on more than these percentages to determine if you qualify for a home loan. Whether you apply for a conventional home mortgage, FHA loan or VA mortgage loan, a lender will consider additional factors, such as your credit history, total assets, and employment history. A lender will also weigh your loan-to-value ratio, which compares the amount of loan you want to the home’s value.
Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering business and finance, health, fitness, parenting and senior living issues for both print and online publications. Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.