Mortgage lenders are chiefly concerned with your ability to repay the mortgage. To determine if you qualify for a loan, they will consider your credit history, your monthly gross income and how much cash you'll be able to accumulate for a down payment. So how much house can you afford? To know that, you need to understand a concept called "debt-to-income ratios."

Debt-to-income ratios

The standard debt-to-income ratios are the housing expense, or front-end, ratio; and the total debt-to-income, or back-end, ratio.

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% 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% 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)

Example

Take a homebuyer who makes $40,000 a year. The maximum amount for monthly mortgage-related payments at 28% of gross income is $933. ($40,000 times 0.28 equals $11,200, and $11,200 divided by 12 months equals $933.33.)
 

Furthermore, the lender says the total debt payments each month should not exceed 36%, which comes to $1,200. ($40,000 times 0.36 equals $14,400, and $14,400 divided by 12 months equals $1,200.)

Example

The following chart shows your maximum monthly payment and maximum allowable debt load based on your gross annual income (remember, gross income is pretax income):

 

Debt-to-income ratio examples
Gross income 28% of monthly 36% of monthly
$20,000 $467 $600
$30,000 $700 $900
$40,000 $933 $1,200
$50,000 $1,167 $1,500
$60,000 $1,400 $1,800
$80,000 $1,867 $2,400
$100,000 $2,333 $3,000
$150,000 $3,500 $4,500

Here's a look at typical debt ratio requirements by loan type:

  • Conventional loans:
    Housing costs: 26% to 28% of monthly gross income.
    Housing plus debt costs: 33% to 36% of monthly gross income.
  • FHA loans:
    Housing costs: 29% of monthly gross income.
    Housing plus debt costs: 41% of monthly gross income.

Taxes and Insurance

In addition, lenders include the cost of taxes and insurance when calculating how much house you can afford:

  • Real estate taxes: Because property taxes are part of your monthly mortgage payment, it is important to get an estimate of what yours would be. Ask your real estate agent or tax office for the rates that apply in the area you want to buy.
  • Homeowners insurance: You must insure your property to obtain a mortgage. You can get an estimate of insurance costs from an insurance agent or insurance company. Be sure to inquire about special requirements for hazard insurance, such as mandatory coverage for floods, earthquakes or wind (in coastal areas). If you put down less than 20% of your home's value, you also will have to obtain mortgage insurance or take out a second loan, called a piggyback loan, to bring the first mortgage down to 80% of the purchase price. Both alternatives will raise your monthly payment.