Housing Expense Ratio: Your Guide To What It Is And How To Calculate Your Housing Ratio
Understanding your housing expense ratio can help you get a better sense of how much home that you can afford when buying a house. The housing expense ratio is used to calculate how much money that you might be loaned for your home purchase.
Here’s a closer look at the housing expense ratio, how it’s influenced by your monthly housing expenses and the impact it can have on home buying.
What’s The Housing Ratio?
The housing expense ratio − which may sometimes be referred to as the front-end ratio − is the percentage of a borrower’s pretax income that goes toward their monthly housing expenses.
To determine the housing ratio, an underwriter divides the borrower’s housing expenses by their gross income. The mortgage lender then analyzes the ratio to decide what loan amount a borrower qualifies for.
At its most basic, the housing expense ratio is a simple percentage that shows how much of your current income goes toward paying for housing.
What Are Considered Monthly Housing Expenses?
Some housing-related costs that are included in the housing ratio include:
- Your monthly mortgage payment
- Property taxes
- Homeowners insurance
- Mortgage insurance
- Homeowners association costs (aka HOA fees)
Note that lenders use both a borrower’s housing expense ratio and their debt-to-income (DTI) ratio to determine eligibility for home mortgage loans.
What’s The Difference Between Housing Expense Ratio And DTI Ratio?
Your debt-to-income (DTI) ratio gives a sense of how much total debt load you’re carrying vs. your income. It factors in other ongoing expenses like credit cards, car loans and student debt.
Conversely, your housing expense ratio specifically relates to housing costs and how they compare to your income.
Be advised that you might also hear of the “28/36 rule” in discussions about your housing ratio. It refers to “28” as your housing expense ratio percentage and “36” as your DTI percentage maximums. Should either exceed these levels, it may be more challenging for you to get a home loan.
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How To Find Your Housing Expense Ratio
Your housing expense ratio is calculated by your mortgage underwriter to determine whether they’ll loan you money and how much. It’s an essential component of the process to determine your eligibility for a mortgage.
The formula to calculate your housing expense ratio is:
Housing Expense Ratio = (Total Housing Expenses / Pretax Income) X 100
Calculate Your Monthly Housing Expenses
How might a mortgage underwriter add up your housing expenses? Let’s take a closer look. For example, let’s use a loan amount of $300,000 on a 30-year loan at a 5.5% mortgage interest rate. Taxes, HOA fees, homeowners insurance, private mortgage insurance and various PITI (principal, interest, taxes and insurance) values used are provided strictly for purposes of example:
- Principal and interest mortgage payment: $1,703
- Estimated property taxes: $300
- Homeowners insurance: $136
- Private mortgage insurance (PMI): $250
- Housing association (HOA) fees: $300
Added together, this brings the borrower’s total monthly housing expenses to $2,689.
Divide Your Housing Expenses By Your Gross Monthly Income
Next, an underwriter would calculate a borrower’s pretax monthly income. For purposes of illustration, let’s assume a family gross income of around $90,000, which further breaks down to $7,500 monthly.
To calculate the housing expense ratio as an underwriter might see it, you can divide your expenses ($2,689) by your income ($,7500). This computes to 0.358, or 35.8%, which means that just over a third of your pretax income would be going toward housing costs.
Analyze The Resulting Housing Ratio
By this point in the process, an underwriter would have an idea that your gross monthly income wouldn’t be enough to qualify for the loan. As noted above, to qualify for a mortgage under the housing expense ratio, you’ll want to keep this figure below 28%. That’s because an underwriter may assume that if your housing ratio exceeds 28%, you may be overextending yourself financially.
Your housing ratio determines, in the eyes of your home lender, whether you can afford a property under the framework of a conventional loan. They don’t wish to put you in a position where you can’t make your mortgage payment..
Some home loan programs, such as Federal Housing Administration (FHA) loans, do allow for larger housing expense ratios. However, you may find that options here are limited.
If your housing ratio exceeds the 28% threshold, you may want to look for ways to reduce your monthly expenses or seek a lower-priced property to purchase.
How To Lower Your Housing Expense Ratio
As noted, with a housing expense ratio above 28%, your borrowing options will be limited unless you can reduce costs or grow your income. You can also strengthen your compensating factors − like improving your credit score or DTI ratio − to offset your high housing expense ratio when applying for a mortgage loan.
Some actions that you can take to improve your chances of securing a mortgage include, but are not limited to:
- Lowering your monthly housing expenses
- Negotiating a raise or finding additional sources of income
- Saving for a larger down payment
- Improving your credit score
- Decreasing DTI ratio
- Paying down debts
- Removing PMI from your loan
The Bottom Line
Your housing expense ratio is an important factor in determining your eligibility to obtain a mortgage. Finding ways to lower it can improve your odds of securing real estate financing.
Interested in finding out more about how much home you can afford, given current housing and lending conditions? You can get the ball rolling by taking time to get started on the approval process today.