When you apply for a home loan, the lender wants to know that you have enough income to pay all your bills on time. How the cost of housing expenses and other monthly debts you owe compare to how much money you earn is something lenders look at when deciding whether to give you a loan. Yet the amount of earnings you need to qualify for a loan depends on more than one financial factor.
What You Can Afford
Before you go house hunting, it makes sense to figure out how much you can afford to pay for a home. When calculating how much home ownership will cost you, factor in the monthly mortgage payment, which includes the loan principal, interest and mortgage insurance if you make a down payment of less than 20 percent of the home’s selling price. Figure in homeowner insurance and property taxes as well. In addition, you will have closing costs and legal fees that average about 2 to 3 percent of the price you pay for a home, notes The Wall Street Journal How-To Home Guide.
Lenders will look at both your front-end and back-end income-to-debt ratios when determining if you qualify for a home loan. As a rule, lenders want no more than 28 percent of your gross monthly income to go toward housing expenses, reports Bankrate.com. You can calculate your front-end ratio by multiplying your annual salary before taxes are taken out by 28 percent, or by 0.28. Divide the amount you get by 12 to arrive at the monthly housing expense you can afford.
Your back-end ratio, or how much of your gross monthly income goes toward all the monthly debts you owe, should account for no more than 36 percent of your gross monthly income. The total of your debt obligations include your mortgage, auto and personal loans, credit card debt, student loan payments, and any child support and alimony payments. Calculate your back-end ratio by multiplying your annual salary by 36 percent, or by 0.36. Then divide by 12 to find your maximum allowable debt-to-income ratio
Even if your debt-to-income ratios are higher than what lenders typically like to see, you might still qualify for a loan if you have savings in the bank, a really high credit score or plan on making a down payment of 20 percent or more. If you’re applying for a home loan through the Federal Housing Administration, you are automatically allowed higher debt-to-income ratios. Generally, an FHA lender will accept a front-end ratio of 31 percent and a back-end ratio of 43 percent. Like conventional mortgage loans, FHA will sometimes accept higher ratios depending on other qualifying factors, according to Bankrate.com.
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.