Most borrowers require a 28 percent housing-to-income ratio

Q. I've heard that most lenders allow a borrower to have a 28 percent debt-to-income ratio in order to qualify for a home loan. What does this mean?

A. In order to minimize the chances of a borrower "getting in over his or her head" financially, most lenders agree that a borrower's monthly housing expense should not be greater than 28 percent of his/her gross monthly income (income before taxes).

For example, if gross monthly income for all wage earners living in the home is $5,000, the monthly housing expense should not exceed $1,400 (5000 x .28). This 28 percent, often referred to as the 'housing-to-income ratio' or 'front-end ratio,' includes the monthly loan payment, real estate taxes/assessments, homeowners insurance, mortgage insurance and association fees (for condo or townhome owners). The allowable percentage can vary by lender, and Federal Housing Administration loans usually have more lenient ratios. The current FHA front-end ratio is 31 percent.

Q. What is the 36 percent debt-to-income ratio?

A. A lender may tell you that the income qualifying ratios are 28/36. The 28 refers to that 28 percent of your gross monthly income that goes toward housing expenses. The 36 refers to the 36 percent of your gross monthly income that goes toward all of your monthly debt (including housing debt). For example, if the gross monthly income is $5,000, 36 percent of that amount equals $1,800. This amount is often referred to as the "total debt-to-income ratio" or the "back-end ratio."

In addition to housing expenses, this sum should include monthly payments on credit cards, installment loans (auto, student loan, etc.), child support/alimony payments or other monthly payments required by a court-ordered judgment. That $1,440 does not include household expenses, such as utilities, food, clothing, entertainment and so forth. It puts a cap on the amount of monthly payments that you are obligated to make. The allowable percentage also can vary by lender and loan circumstances. With an FHA loan this total back-end ratio can be stretched to 43 percent.