Before you apply for a mortgage loan, you will need to ensure you are earning enough to qualify for the loan amount you are asking for. Mortgage lenders use a ratio called the debt-to-income ratio in order to determine whether you earn enough to qualify for a particular mortgage loan. The debt-to-income ratio compares the amount you earn with the amount you owe to your creditors. Knowing this number can help you determine how much house you can afford for your paycheck.

## Definition

Your debt-to-income ratio is the amount of your paycheck (and any other income) that is spent on your debts. Things such as food and household bills are not included in the calculations, but mortgage payments, taxes on your house and home insurance are included. The income used in the calculations is your gross income--your income before taxes. The debt-to-income ratio is expressed as a percentage--the percentage of your income spent on debt. The lower the percentage, the better your prospects of getting the mortgage loan. Lenders use two types of calculation to arrive at a debt-to-income ratio: front-end income and back-end income.

## Front-end Income

Your front-end income is the highest proportion of your monthly income that can safely be spent on your mortgage payment. This number is calculated by taking your total monthly mortgage costs, including mortgage payment, taxes, homeowner's dues, property and mortgage insurance payments, etc. and dividing this number by your gross monthly income. The resulting amount is the most money the lender believes you can afford to dedicate to your mortgage each month. Most lenders will look for a front-end ratio of around 33 percent or lower. The Federal Housing Administration (FHA), which guarantees loans to many first-time buyers with poor credit, looks for a front-end ratio no higher than 29 percent.

## Back-end Income

Your back-end income takes into account all of your monthly debt, not only your mortgage debt. To calculate this figure, you first add up all of your monthly debt, including total monthly mortgage costs, as above, credit card payments, car loans, student loans, court-ordered child support and any other outstanding monthly debt payments, and then divide this by your total monthly gross income. Lenders usually look for a back-end income ratio no higher than 38 percent, although the FHA will approve mortgage loans to people with a back-end ratio as high as 40 percent.

## Maximum Mortgage to Paycheck

You can also easily calculate the highest monthly mortgage payment you can afford for your paycheck. To find your front-end maximum, first divide your annual gross income by 12 (as there are 12 months in the year). Then multiply this number by the maximum front-end ratio normally allowed: 33 percent (0.33). To determine your back-end maximum, multiply your gross monthly income by 38 percent (0.38). Then subtract all of your regular monthly debt payments from the resulting number. What is left over is the maximum monthly mortgage payment most lenders will approve.

#### References

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