Before You Apply For A Home Loan, Understand Your Expense to Income Ratio
In the hunt for your dream home, there are lots of numbers at play: the sale price of each property you look at, the mortgage interest rate you hope to get, the total in your down payment savings account, biannual property tax payments, monthly homeowner’s insurance premiums and more. If you’re like most prospective buyers, you’ve probably even done some number-crunching already to determine how much you can afford to pay for your future home.
One number many prospective buyers overlook, however, is the expense to income ratio. That is, the amount you the buyer plan to spend monthly for mortgage payments, taxes and insurance, versus your total pre-tax income each month. Mortgage lenders commonly use this ratio to determine whether a prospective buyer is creditworthy or, conversely, poses too much of a financial risk.
Typically, mortgage lenders are looking for an expense to income ratio that is 28 percent or less, which is considered “safe” by the Federal Reserve. To calculate yours, add up the prospective mortgage payment, insurance payment and property tax bill for each month, making sure to include interest, and divide that total by your monthly pre-tax income. For example, if the lender determines your monthly mortgage payment will be about $1,200, plus $125 in property taxes and $60 in insurance, your total monthly housing costs are $1,385. If your monthly pre-tax income is $5,500, your expense to income ratio is about 25 percent – in the safe zone.
Might you be able to afford spending a higher percentage of your income on housing costs? Sure. No one understands your financial picture better than you do. However, lenders have to be concerned about their own bottom line, and most won’t consider financing buyers who are planning to exceed that 28th percentile.
Understanding where your expense to income ratio falls before you apply for a mortgage will help you narrow your property options and strengthen your home loan application.
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