How to Evaluate the Ability to Pay a Mortgage Loan

Debt-to-income ratios tell you the payment you can afford on your house.

Debt-to-income ratios tell you the payment you can afford on your house.

Before you and your significant other shop for a home loan, you can evaluate the amount of mortgage payment you can afford based on typical lending guidelines. A lender uses two “debt-to-income” ratios to determine your ability to pay a mortgage loan. The front-end debt-to-income ratio compares your monthly housing costs to your monthly gross income. The back-end debt-to-income ratio compares your monthly housing costs plus monthly non-housing debt payments to your gross monthly income. These ratios tell you the maximum payment for which you might qualify if you meet a lender’s other requirements.

Step 1

Add together the amount you and your spouse earn per month before taxes to determine your gross monthly income. For example, assume each of you earn $5,000 per month before taxes. Add $5,000 plus $5,000 to get $10,000 in gross monthly income.

Step 2

Multiply your gross monthly income by 28 percent, or 0.28, to determine the maximum monthly mortgage payment you can afford based on a typical front-end ratio for a conventional loan. This maximum allowable payment includes your principal, interest, taxes, homeowners insurance, mortgage insurance premium and homeowners’ association fees. In this example, multiply $10,000 by 0.28 to get $2,800, which means you can afford up to $2,800 per month on your total monthly mortgage payment, based on the front-end ratio.

Step 3

Determine your and your spouse’s total monthly non-housing debt payments, such as car loans, student loans and credit cards. For example, assume you and your spouse pay $1,000 in total monthly non-housing debt payments.

Step 4

Multiply your gross monthly income by 36 percent, or 0.36, to determine the total monthly debt payments you can afford, including your mortgage payment and non-housing debt payments, based on a typical back-end ratio for a conventional loan. Continuing the example, multiply $10,000 by 0.36 to get $3,600, which means you can afford up to $3,600 per month in total debt payments.

Step 5

Subtract your monthly non-housing debt payments from your result to determine the maximum monthly mortgage payment you can afford based on the back-end debt-to-income ratio. In this example, subtract $1,000 from $3,600 to get a $2,600 maximum monthly mortgage payment.

Step 6

Determine the lower maximum mortgage payment between the two debt-to-income ratios to determine the maximum monthly mortgage payment you can afford. In this example, the $2,600 back-end ratio mortgage payment is the lower payment of your two ratios, which means you can afford up to $2,600 for a total monthly mortgage payment. Although you can afford $2,800 based on the front-end ratio, this amount would exceed the allowable back-end ratio percentage when combined with your other debt payments.

Tip

  • Some loans, such as those insured by the Federal Housing Administration, or FHA, allow higher percentages in your debt-to-income ratios, which may allow you to qualify for a higher payment.

About the Author

Bryan Keythman has performed stock investment research and writing for a consulting firm since 2008. He also has prior experience sourcing and underwriting commercial real-estate investment and development opportunities for a commercial real-estate developer. Keythman holds a Bachelor of Science in finance.

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