Income Requirements to Buy a Home

Money-jar-128It’s not all about the take-home pay when buying a home.  Banks look at both your INCOME and DEBT when deciding whether you qualify. They rely on two ratios, often called the “front-end” debt-to-income (DTI) ratio and the “back-end” debt-to-income 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.

DTI ratios change by Fannie Mae and FHA decree, so it’s important to contact your lender to determine what DTI ratios are required for your type of loan and your financial situation, but a DTI front-end ratio of 31% and back-end ratio of 43% is a good place to start.

The front-end debt-to-income 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%

At a front end ratio requirement of  31%, the above scenario would work.  Note that conventional loans may not have a front end ratio requirement.

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 your proposed 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 45%, though some loan products offer higher back-end ratios, especially if your credit score is good.

Our affordability mortgage calculator  can determine what home price you can afford based on these front end and back-end ratios. For example, I’ve entered a $4000 per month income and $425 per month in debt payments.

Given a 31% front end ratio and 45% back end ratio, I can afford a $223,600 home at payments of $1266 per month (mortgage, taxes and insurance.

If these numbers work out for you, you’re on the right path to home ownership!  But before you start on your house hunting adventure (the fun part!),  don’t forget to check your credit and make sure there are no errors on your report.