Table of Contents
What Is a Housing Expense Ratio?
Let me explain what a housing expense ratio is—it's the percentage of your pre-tax income that you spend on housing expenses. Lenders use this ratio, often called the front-end ratio, to decide if they'll approve you for a mortgage. You calculate it by dividing your housing expenses by your income and multiplying by 100.
Key Takeaways
The housing expense ratio represents the portion of your gross income going toward housing expenses, which can include mortgage payments, insurance, property taxes, and other related costs. Lenders evaluate this ratio to assess your credit profile for a mortgage loan. In general, they prefer it to stay below 28%.
How a Housing Expense Ratio Works
The housing expense ratio, or front-end ratio, is what mortgage lenders use to determine if you can afford a mortgage. You get this figure by dividing your monthly housing expenses by your monthly gross income and multiplying by 100. These expenses might include your mortgage payment, mortgage insurance, and property taxes. Lenders consider this ratio along with others, like your debt-to-income ratio, to decide on loan size. These income ratios are vital in the underwriting process and can prevent approval even if your credit score is strong.
If you're thinking about a mortgage or any loan, calculating your housing expense ratio helps you figure out how much you can afford to borrow.
Housing Expense Ratio vs. Debt-to-Income Ratio
The housing expense ratio is known as the front-end ratio because it's a key part of your overall debt-to-income ratio, and it often comes first in the underwriting process for mortgages. Both ratios use your pre-tax or gross income as a base. To calculate the housing expense ratio, an underwriter adds up all your housing obligations, including potential mortgage principal and interest, property taxes, hazard insurance, mortgage insurance, and association fees. Then, they divide that sum by your pre-tax income. You can do this with monthly or annual figures.
The typical threshold for housing expense ratio in mortgage approvals is 28%, though it can vary by lender.
Debt-to-Income Ratio
Debt-to-income ratio is another essential factor in loan approvals. When you're up for a mortgage, the lender looks at the average monthly payments you make to creditors from your credit report. They divide your total debt payments by your monthly income. Usually, you need a debt-to-income ratio of 36% or less, but it could go up to 45% with good credit. Underwriters consider how a new mortgage payment would stress your finances and overall debt. In underwriting, they run scenarios with hypothetical mortgage payments to see impacts on both ratios.
Lending Standards
A housing expense ratio above 28% might still be okay if you have strong other factors, like a low loan-to-value ratio or excellent credit history. Applying with a co-borrower can help lower the ratio. A variable rate loan with smaller initial payments could also improve your initial ratio for approval. If you're planning a home loan, use the 28% and 36% guidelines for budgeting your monthly expenses. Keeping housing costs at 28% of income gives you an estimate of affordable mortgage payments. Maintaining total debt-to-income below 36% makes it easier to get other credit or loans, including mortgages.
What Is the 28/36 Rule for Housing Expenses?
The 28/36 rule means you should not spend more than 28% of your gross monthly income on housing payments, like rent or mortgage, and no more than 36% on total debt, including credit cards or personal loans.
What Is Household Expenses Ratio?
A household expenses ratio is for budgeting and includes daily costs like groceries, utilities, and necessities—it's different from the housing expense ratio, which focuses only on housing costs versus income for lender use. Aim to keep your household expense ratio under 50%.
What Is the Maximum Housing Ratio?
Lenders differ on maximum housing expense ratios, but they generally want it under 28% or 25%. Even if approved for an amount, make sure it fits your budget—approval doesn't guarantee affordability.
The Bottom Line
Understanding the housing expense ratio is key for your finances, especially when applying for a mortgage. Lenders use it to check if you'll meet obligations. A lower ratio means less risk to them, so keep yours in check.
Other articles for you
Yearly Renewable Term (YRT) is a one-year life insurance policy that renews annually with increasing premiums based on age.
This text explains the definition, types, mechanics, and uses of futures contracts in financial markets.
A qualified pre-retirement survivor annuity (QPSA) is a death benefit paid as a life annuity to the surviving spouse of a deceased employee under a qualified retirement plan.
Underwriting fees are payments received by underwriters for managing risks and facilitating the issuance of securities, mortgages, or insurance policies.
Transfer pricing is the method used to set prices for transactions between related entities within a company, often to manage profits and taxes across divisions or countries.
Interest rate risk is the potential loss in value of bonds and fixed-income investments due to changes in prevailing interest rates.
The International Chamber of Commerce (ICC) is the world's largest business organization promoting international trade, setting rules, and resolving disputes for millions of companies globally.
A recessionary gap occurs when a country's real GDP falls below its potential at full employment, leading to economic downturns and higher unemployment.
Money laundering disguises illegal funds to appear legitimate through various methods and is combated by global regulations.
Skin in the game means company insiders investing their own money in the business they manage to align interests with outside investors.