When you're ready to buy your new home, your mortgage-to-income ratio is one of two ratios that lenders look at to determine what loan amount and monthly payment you can afford. Computing this ratio requires having an estimate of your expected monthly housing costs as well as your total monthly gross income from all sources. When you divide your housing costs by your gross earnings, lenders usually want to see that this figure is 28 percent or less. While some loan programs allow for a higher number, it can signal you're stretching your budget and may have trouble affording your new home.
TL;DR (Too Long; Didn't Read)
To calculate your mortgage-to-income ratio, divide your total monthly housing costs by your monthly gross earnings. Multiplying that value by 100 will give you a percentage, which normally should be 28 percent or less to meet mortgage lender guidelines. A mortgage qualification calculator can give you an idea of the home price you can afford.
Basics of the 28/36 Rule
The 28/36 rule gives you a standard to follow so that you can avoid taking on too much new debt and have a better chance of mortgage approval. The first half of this rule – the front-end ratio or mortgage-to-income ratio – states that you should ideally spend 28 percent or less of your pretax earnings on housing costs. This includes your mortgage principal and interest, homeowners' insurance, mortgage insurance (if applicable), homeowners' association fees (if required) and property taxes.
The other half – the back-end ratio or total debt ratio – implies that your total monthly debt expenses (including the housing costs) should not go above 36 percent of your gross earnings.
Importance of Debt Ratios
When you're just beginning your house hunt, calculating your mortgage-to-income and back-end ratios can give you an idea of how much you can spend each month on your mortgage and whether a house you see is within reach. For example, you can use an online mortgage calculator to plug in a home's price and your intended down payment along with estimated property tax, insurance and HOA fee amounts. The result will show you an estimated monthly mortgage payment that you'll be able to use with your income information to calculate your mortgage-to-income and back-end ratios and assess affordability.
If you're already in the mortgage application process, your ratios are one of the critical factors your lender will look at to determine how much of a mortgage you can get. While having your ratios at 28/36 or lower can improve your chances of getting the mortgage, some loan programs do allow for higher ratios, sometimes depending on compensating factors like a big down payment or a high credit score.
For example, Federal Housing Administration loans may have a mortgage-to-income ratio as high as 31 percent and a back-end ratio of between 43 and 50 percent, and conventional loan underwriters may allow for these higher back-end ratios as well. Magnify Money notes that underwriters of Veterans Affairs loans can make judgments on the back-end ratio.
Calculating Your Mortgage-to-Income Ratio
If you already have a house in mind or at least have obtained an estimated housing payment from an online mortgage qualification calculator, calculating your mortgage-to-income ratio is straightforward with a few steps:
- Add the monthly mortgage principal plus interest, homeowners' insurance, property taxes, any mortgage insurance and any HOA fees to get your total housing costs.
- Add all of your gross monthly income – including what you make from your job, self-employment, alimony or child support, investment income, retirement income, disability income and any other source – to determine your gross monthly earnings.
- Divide your monthly total housing costs by your total monthly pretax earnings and then multiply the figure by 100 to get a percentage. For example, if your housing costs are $1,200 and your earnings are $5,000, then your ratio would be $1,200/$5,000 = 0.24, which is 24 percent.
When you don't know your housing costs but want a quick way to know the maximum you might afford based on your income, you can simply multiply your pretax income by 0.28. For example, if you make $5,000 a month, then you'd multiply $5,000 by 0.28 to get a maximum housing payment of $1,400 a month.
If you'd rather not do these calculations by hand, you can usually find a mortgage-to-income calculator that will have you enter all of your income information. The mortgage-to-earnings calculator will use this data to provide an estimate of a mortgage amount and monthly payment you could afford.
Calculating Your Back-End Ratio
Even if your mortgage-to-income ratio falls below the limits, your other debts might cause you to exceed the maximum back-end ratio for your loan program. To get a better picture of your debt compared to your income, use these steps to check your back-end ratio:
- Add your estimated housing costs along with all other monthly debt payments – including any car loans, student loans, credit cards, personal loans, installment plans, child support payments and other debts.
- Get the total gross monthly income amount that you used to calculate the front-end ratio.
- Divide your total debt costs by your pretax income and multiply the value by 100 to get your back-end ratio as a percentage. For example, if your total monthly debts are $2,000 and you earn $5,000, your back-end ratio is $2,000/$5,000 = 0.40, which is 40 percent.
You can also find debt-to-income calculators on the Wells Fargo, Zillow, Bankrate and other banking websites. These tools allow you to conveniently itemize your debt and income sources and will do the calculation automatically.
Using a Mortgage Qualification Calculator
After computing your ratios, you may find it helpful to experiment with an online mortgage qualification calculator to see how different mortgage amounts, down payments, debt levels, income amounts and credit profiles will impact affordability for you. If your mortgage-to-income ratio looks like it will be high, you can try plugging in a bigger down payment or smaller mortgage amount to see how it changes. You can also learn how reducing your existing debt or increasing your income will impact your maximum mortgage amount.
Consider also speaking with a lender who can take your income and debt information and calculate how much you may be able to borrow for your home. You can complete this prequalification process over the phone, in person or online, and you'll usually know within a day, sometimes even instantly. The lender can also address any concerns you have about your ratios and suggest potential mortgage programs for your financial situation.
Improving Your Ratios
Since the mortgage-to-income ratio depends solely on housing costs, you can reduce it with a larger down payment, which lowers the total loan amount. If you're having trouble saving a sizable down payment, look into any down payment assistance or first-time homebuyer programs your state might offer; you could also ask family members for some funds as a gift. If the place where you want to live has high property taxes, you could consider seeking a house in an area with lower taxes. Since HOA fees can run high and spike up your front-end ratio, looking for places without these costs can also help.
Besides lowering the housing costs, a good way to reduce your back-end debt ratio is to pay down other debts if possible. This could mean paying off a car loan or high-balance credit card. However, you'll want to balance this with having enough money for your down payment, closing costs, emergency fund and any cash reserves your lender requires.
- Ohio Housing Finance Agency: Down Payment Assistance
- Investopedia: 28/36 Rule
- Bankrate: How Much House Can I Afford?
- Chase: Affordability Calculator
- Magnify Money: Debt-To-Income and Your Mortgage: Will You Qualify?
- Credit Karma: Fannie Mae Increases Debt-To-Income Ratio Limit – So Who Benefits?
- Fannie Mae: B3-6-02: Debt-to-Income Ratios (08/07/2019)
- Discover: What Income Is Considered When Applying for a Mortgage?
- NerdWallet: Mortgage Calculator
- Mortgage-to-income and debt-to-income ratios are just guidelines to follow in figuring out how much home you can afford. The amount of mortgage you will qualify for depends on the unique loan criteria your lender sets.
- When considering how much mortgage you can afford, think about how you would afford your mortgage if you or your spouse were unemployed for a significant period of time. You may avoid foreclosure by opting for a mortgage you could afford with only one household income.
Ashley Donohoe has written about business and technology topics since 2010. Having a Master of Business Administration degree and experience running a small business and doing tax returns, she is knowledgeable about the tax issues individuals and businesses face. Other places featuring her business writing include JobHero, LoveToKnow, Bizfluent, Chron, Zacks, PocketSense and Study.com.