The housing expense ratio, also known as the housing ratio, is a useful method to understand how much one can spend on a house. Most lenders or financial institutions will consider this while underwriting analysis for a mortgage. Keep reading to know more about the housing expense ratio, how it works, and how it can affect your home buying process.
What Do You Mean By The Housing Expense Ratio?
The housing expense ratio is calculated by dividing all of a borrower’s monthly housing expense obligations by the borrower’s pretax income or gross monthly income.
Using this, the mortgage lenders may know how much you are paying for housing, and it also considers your private mortgage insurance, mortgage payments, gross income, taxes, and other factors.
Most financiers use this to know whether you qualify for personal finance or mortgage. To get approved by a finance company, you should try your best to keep the score at 28 percent or below.
How To Calculate Housing Expense Ratio
It doesn’t involve any complex formulas, and you don’t even need a digital calculator for this. Just a few common metrics and you are ready to calculate this. To help you out with this, we have mentioned-down a step-by-step guide for you.
Combine All Your Housing Expenses
You can have to combine all the housing-related expenses or housing costs. Let’s understand this with an example.
You need a loan of USD 300,000 at a 32 percent interest rate for 30 years. The HOA fees, insurance, taxes, etc., used here depend on the national averages. Besides, you need to consider the following fees:
- Property taxes- USD 300
- Insurance- SD 350
- The interest mortgage payment and initial principle- USD 1100
- Fees for housing association- USD 300
- For homeowners insurance- USD 150
When you combine all these expenses, you will get USD 2200. Keep in mind that it doesn’t cover the total cost of your home.
Your Total Gross Salary
Once done with the housing expense, you need to calculate your monthly gross income. For example, you earn USD 9000 every month.
While calculating your salary, you will have to consider your bonuses, alimony, child support, and more.
Dividing By Your Pretax Income
To get your housing expense ratio, you need to divide your total housing costs by the income you make every month. So, the formula is:
USD 2200 / USD 9000= 0.244. When you convert that into a percentage, you will get approximately 0.24 percent.
As per this example, you will spend 27 percent on the expenses related to your house.
Evaluating The Outcome
As per the rule, to qualify for a good mortgage, your housing expense ratio should be below 28 percent.
As your housing expense ratio is 27 percent, getting approved by lenders will be easier for you.
However, some financial institutions (you can find them by doing extensive market research) can offer you a mortgage even if your housing expense ratio is more than 28. But you will have to deal with a bigger down payment.
Different Types of Housing Expenses
Your housing expenses per month can be the total of the following:
- Monthly mortgage payments or any annual payments
- Interest payments and principle
- Real estate taxes
- Mortgage insurance, property taxes, debt, and more
- Special assessments
- Any dues related to owner’s association
- Monthly co-op corporation payments
Why Should Every Borrower Consider Their Housing Expense Ratio?
Evaluating your housing expense ratio can provide you with more confidence. By knowing the housing expense ratio, you will get an idea of whether you can meet the mortgage criteria of the lenders. It will also help you analyze if you are a strong candidate for some lenders.
However, you should forget that other factors can affect your chances of getting approved by a lender., like your creditworthiness and debt to income ratio. A higher borrower’s income level can also help him qualify for a mortgage.
If your housing expense ratio is a little high, then don’t worry, as your strong credit score can help you get a loan. You can get a credit report for free from government-run agencies.
Understanding Debt To Income Ratio Vs. Housing Expense Ratio
You should get confused with the housing expense ratio and debt to income ratio (DTI ratio) as these two are different. Let’s explore the major differences between them.
Speaking about the housing expense ratio, it includes all the PITI expenses that you do every month. Besides, most mortgage lenders prefer the housing expense ratio to be 28 percent or less. However, they may allow some exceptions based on the mortgage loan types. For example, they check the borrower’s credit profile, and if the borrower has an excellent credit history, they may offer a loan.
On the other hand, you can improve the housing expense ratio by applying for a less expensive mortgage loan or making a larger down payment to lower your monthly payment amount.
Now, coming to the debt to income ratio includes all your PITI and other debts that you pay every month, like your monthly mortgage payments and more. It includes your credit card payments, student loan, personal finance, auto loan, and other debt obligations or loan programs. Most lenders prefer this to be 36 percent or less than that. However, lenders may still offer you a loan if you have a 45 percent DTI ratio.
The housing expense ratio requires information about the applicant’s pre-tax income ratios, which is essential for both DTI and housing expense ratios.
While carrying out your house hunt process to find an affordable home, you should make sure that you have a food debt to income ratio and house to income ratio to make it easier to get a loan. Besides, ensure that your creditworthiness is good.
Understanding The 28/36 Rule. How Can It Affect Your Mortgage Loan?
Under this rule, the number 36 is your debt to income ratio, and the number 26 is your housing expense ratio.
When utilized combined, the DTI ratio is called the back-end ratio, and the housing expense ratio is the front-end ratio.
While your housing expenses ratio includes all your housing expenses, the DTI includes factors like student loans, homeowners insurance, automobile loans, child support, gross monthly income, and more.
If you pay more than 36 percent of your income to pay your monthly debts, getting mortgage loan approvals can be very difficult. You can clear the previous monthly mortgage debt on time to lower the DTI. Once reduced, you can apply for a loan. Keep your debt as low as possible and develop an on-time mortgage payment habit.
You can say that housing expense ratios, also called the house-to-income ratios, are effective and a quick way for your lender to decide how big a house you can easily afford.
On the other hand, it is also a great way to keep your credit score high, as you will not apply for multiple loans if the ratio is higher than 28 percent.
If you plan to apply for a housing mortgage, you should calculate this before you even apply to prevent any rejection. Besides, keeping monthly housing expenses low will be a good option to keep the ratio low. Another thing that you can do is increase your pre-tax income. You can lookout for a better job. Experts also suggest increasing your credit score.
The Key Takeaways:
- It can help understand the borrower’s ability to afford a new house or pay the debts on time.
- It also shows the percentage of total gross salary or income required to pay monthly payments, mortgage insurance, and more easily.
- You should try to keep it below 28 percent to easily increase your chances of getting a loan to make your home buying process comfortable.
- Frequently keep checking your debt to income and housing expenses ratios to increase your likelihood of getting the maximum amount of a mortgage.
- If you have a good credit score, you may be able to apply for a mortgage even if the ratio is high.