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It is very common and usual for lenders to use debt-to-income ratios to determine your eligibility for a loan and how much they will lend you. There are two debt-to-income ratios that banks check based on the information you provide on your loan application.
Front-End Ratio
First, they check to see how much of your income would go toward the mortgage payment. This is called the front-end ratio. Their guideline is that your total payment, including principal, interest, and escrow payments, should not be more than 28% of your gross (pre-tax) monthly salary. To calculate this, take your gross annual salary and multiply it by .28, then divide it by 12. This number is your maximum total mortgage payment per month. Back-End Ratio
Lenders also check how much of your gross income is required to pay all of your debts combined. This is called your back-end ratio and includes the mortgage as well as car payments, credit card payments, student loans, child support, and alimony payments. Their guideline for this ratio is that your total debt payments should not be more than 36% of your gross income. To calculate this, take your gross annual salary and multiply it by .36, then divide it by 12. This is the maximum allowable amount of your total monthly debt payments. Don't Be House Poor
Be cautious with these numbers however. Just because a lender says they are willing to lend you a certain amount, doesn't mean you need to borrow that amount! Instead, consider your own budget and lifestyle, and make sure you don't end up with such a high mortgage payment that you can't put money away for retirement, go for a nice vacation, or even go out to eat. Some debt counselors recommend that your total payment should not be more than 28% of your net pay (after taxes), leaving you money for a comfortable lifestyle as well as the other costs of home ownership, such as repairs, maintenance, and higher utility bills. Another common rule of thumb is to not buy a house that costs more than two and a half times your current annual salary.
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