Lenders use formulas called qualifying ratios to calculate how much of a mortgage you qualify for. These ratios are based on your gross monthly income, your housing expenses, and your long-term debt.
The Front Ratio
Housing Expense to Income Ratio
The first qualifying ratio a lender scrutinizes is your housing expenses to income ratio (known as the front ratio). In many cases, lenders prefer your housing expenses to not exceed 28 percent of your gross monthly income. Your monthly housing expenses include mortgage principal, interest, taxes, and insurance; consequently, this ratio is often abbreviated as PITI.
The Back Ratio
Housing Expenses Plus Long-term Debt to Income Ratio
The second ratio that a lender looks at (known as the back ratio) is one that takes into account your expenses on long-term debts that extend 11 months or more into the future (e.g., a car or student loan). Your monthly housing expenses, plus your other long-term debt, determine what’s known as your debt ratio. To qualify for a conventional mortgage, many banks indicate that these expenses generally should not exceed 36 percent of your gross monthly income.
Example: If your gross annual income is $30,000, your gross monthly income is $2,500. Your front ratio (PITI) should not exceed more than 28 percent of this, or $700. Your back ratio when including your other debt should not exceed $900 (36 percent of $2,500). Mortgages that are insured or guaranteed by the federal government may allow more liberal qualifying ratios. Federal Housing Administration (FHA) loans may allow front ratios as high as 29 percent and back ratios of 41 percent (sometimes abbreviated as “29/41”), while Department of Veterans Affairs (VA) (link) loans may allow up to 41 percent for both ratios. Remember that the figures provided are estimates. Qualifying ratios may vary from lender to lender, and each mortgage application is considered individually.
Keep in mind that some lenders may allow higher ratios if you have excellent credit, a large down payment, or substantial savings, or meet other conditions.
Tip: Now might be the time to think about revising your budget. Perhaps you can think of ways to reduce your non-housing-related expenses; doing so will free up money that you can apply toward your housing costs.