Income Requirements to Buy a Home
Though I’ve stressed a good credit score as crucial for receiving a good interest rate, banks will also look at your income and debt when deciding whether you qualify. They rely on two ratios, often called the “front-end” ratio and the “back-end” ratio. You can calculate these ratios yourself and determine how much home payment you can afford and the home payment the banks say you can afford.
The front-end ratio (also sometimes known as the housing ratio) is the amount of your monthly house payment divided by your gross (before taxes) monthly income. To calculate your monthly house payment, add up the interest and principle payments, taxes and homeowner’s association dues. Here’s an example:
| Principal and interest: | $800 |
| Monthly property tax: | $50 |
| Home Owners Assoc: HOA Fees | $50 |
| Total payment: | $900 |
| Monthly Income: | $3000 |
| Front end ratio: $900 / $3000 = .3 or | 30% |
Front end ratio requirements are usually 28%, though some loan products allow up to 40%.
The back-end ratio is where many borrowers get tripped up. To calculate the back end ratio, you’ll add up all your debt, including the housing debt you used in the front-end ratio and any credit card payments, car payments, and student loans, along with most other installment loans you currently pay. If your total monthly debt, including house payment, is $1200, and your monthly income is $3000, your back-end ratio is $1200/$3000 = .4, or 40%. Many lenders require a back-end ratio of no more than 36%, though some loan products offer back-end ratios of up to 50%, especially if your credit score is good.
I’ve included an affordability mortgage calculator that will determine what home price you can afford based on these front end and back-end ratios. You can play with the numbers, increasing your down payment and decreasing your debt to determine what steps you can take to afford the home of your dreams, or at least the home you want to have now.
Now that I’ve mentioned these ratios, there is a way around them if you have an unsteady or rising income, and that is “stated income”. With stated income, your lender will plug in the monthly income you “state” that you’ll have in the coming years. Stated income is an important qualifying tool for self employed people or those that have erratic bonuses or investing income. Stated income is also most often available for those who have good credit scores.