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How do Lenders determine your Budget?

In our previous post, we discussed misconceptions some home shoppers have when it comes to down payment and credit score requirements. In this post, we want to shed some light on how your home budget works. When you apply for a home loan, your lender will determine your budget using a simple calculation to come up with a percentage. This percentage is called your debt-to-income ratio.

How Lenders determine your Budget

 

How Lenders determine your Budget

Your spending budget will be determined using two debt-to-income ratios. These two ratios are referred to as your “front-end” and “back-end” ratios.

Front-end –  this compares your new total monthly housing payment against your monthly gross income.

Example:

New Total Monthly Housing payment – $1,400
Monthly Gross Income – $5,000

To calculate this percentage, you simply divide the gross monthly income by the new total monthly housing payment.

$1,400 / $5,000 = 28%

Ideal Front-end ratio = 28% or lower
Max Back-end ratio = 31 – 36% (varies per program and exceptions may be granted)

Back-end – this compares your new total monthly housing payment PLUS your “Other” recurring monthly expenses against your monthly gross income.

Example:
New Total Monthly Housing payment- $1,400
“Other” Monthly – $300 (Auto Loan)
“Other” Monthly – $200 (Student Loan)
New Total Monthly Expenses – $1,900
Monthly Gross Income – $5,000

To calculate this percentage, you add all of your “Other” Monthly recurring expenses to your New Total Monthly Housing payment. Then you divide your gross monthly income by the new Total Monthly Expenses.

$1,400 + $300 + $200 = $1,900
$1,900 / $5,000 = 38%

Ideal Back-end ratio = 38% or lower
Max Back-end ratio = 43% – 45% (varies per program and exceptions may be granted.)

DEFINITIONS

Total Monthly Housing Payment Breakdown:

  • Principal & Interest payment
    Property Taxes
    Hazard Insurance
    Flood Insurance (if applicable)
    Mortgage Insurance (if applicable)
    Homeowners Association (HOA) (if applicable)

 

Examples of “Other” Monthly Liabilities:

  • Auto Loan(s)
    Personal / Installment Loan(s)
    Credit Card(s)
    Child Support / Maintenance
    Alimony
    Collection Accounts
    Student Loan(s)

Examples of monthly liabilities excluded from debt-to-income ratio calculations:

  • Utility Expenses (heat/electric/gas)
    Phone
    Cable
    Gym Memberships

Gross Monthly Income: Income before taxes are taken out.

As a general rule, it is always best to speak with a mortgage loan officer well in advance of your actual home search. The more prepared you are going in, the better off you will be in the end.

For more information on debt-to-income ratios, you can visit FHA’s website here and FannieMae’s website here.

 

CanIBuyIt
CanIBuyIt is dedicated to informing homebuyers on their financing budgets.

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