How to Determine Monthly Housing Cost Limits
Budgeting is the key to having a happy, secure financial life. Here are some guidelines that may help develop your own housing cost limits:
- Income - Calculate your provable gross income from your employment. Things such as overtime and bonuses that haven’t been regular for at least two years won’t be counted by a lender, but if you will continue to receive them, make a note of it for future reference as it may increase your comfort level. Consider too if a non-working spouse will be able to get a job.
- Debt - Calculate the total amount of your debt payments (for example: car loan, credit cards, insurance, etc.) If you are unclear about the exact numbers, get a credit report so you can use the same monthly payment numbers that your lender will.
- Debt-to-Income - Determine your debt-to-income ratio by calculating your monthly income vs. expenses and see where you fall under the guidelines below.
Front-end ratio: The housing expense, or front-end, ratio shows how much of your gross (pretax) monthly income would go toward the mortgage payment. As a general guideline, your monthly mortgage payment, including principal, interest, real estate taxes and homeowners insurance, should not exceed 28 percent of your gross monthly income. To calculate your housing expense ratio, multiply your annual salary by 0.28, then divide by 12 (months). The answer is your maximum housing expense ratio. Front-end ratio: Maximum housing expense ratio = annual salary x 0.28 / 12 (months)
Back-end ratio: The total debt-to-income, or back-end, ratio, shows how much of your gross income would go toward all of your debt obligations, including mortgage, car loans, child support and alimony, credit card bills, student loans and condominium fees. In general, your total monthly debt obligation should not exceed 36 percent of your gross income. To calculate your debt-to-income ratio, multiply your annual salary by 0.36, then divide by 12 (months). The answer is your maximum allowable debt-to-income ratio. Back-end ratio: Maximum allowable debt-to-income ratio = annual salary x 0.36 / 12 (months)
- Current Expenses - Examine what you are now paying for housing. Ask yourself how comfortable are you with paying your current expenses and it will help determine whether you are ready to commit to a larger mortgage.