As much as you're looking to find the lender that will offer you the lowest interest rate, banks are looking to find borrowers who have the ability to repay the mortgage on time. Banks use two income ratios to measure how much you can afford to spend monthly on housing -- including homeowner's insurance, property taxes and, if required, private mortgage insurance. The front-end ratio measures the cost of your mortgage relative to your total monthly income while the back-end ratio measures all of your debt payments, including your housing expenses, relative to your monthly income.
Divide your annual pretax income by 12 to figure your monthly income. For example, if your annual income is $96,000, divide $96,000 by 12 to get $8,000 per month.
Multiply your annual pretax income by the front-end ratio percentage allowed by your lender. For example, if your lender will let your mortgage expenses go up to 28 percent of your income, multiply $8,000 by 0.28 to find that you can spend up to $2,240.
Multiply your annual pretax income by the back-end ratio percentage allowed by your lender to find the starting point for your back-end ratio limit. For example, if your back-end ratio percentage is 36 percent, multiply $8,000 by 0.36 to get $2,880.
Subtract any other monthly debt payments, such as car payments or student loans, from the starting point for the back-end ratio to figure your maximum mortgage costs using the back-end ratio. In this example, if you have a $300 student loan payment and a $500 car payment, subtract $800 from $2,880 to get $2,080.
Use the smaller of your front-end ratio limit or your back-end ratio limit as the cap for your monthly housing expenses. In this example, since your back-end ratio is smaller than your front-end ratio, use $2,080 as the maximum monthly expenses for your home loan.
- Jupiterimages/Comstock/Getty Images
- The Purpose of Debt Ratio
- How to Estimate a Single Household Budget
- What Percentage of Your Salary Should Go for a Mortgage?
- How Much Should I Have After Paying Mortgage & Expenses?
- Understanding Debt Management Ratios
- Definition of Gross Income for Mortgage Calculation
- Simple Family Budget
- How Do I Figure How Much Money the Lender Is Allowed to Require in My Escrow Account?