How to Calculate Your Housing Expense Ratio

Your housing expense ratio, which compares your housing costs to your gross monthly income, tells you what  portion of your earnings goes toward housing expenses. Understanding this ratio can help you decide whether your housing costs are within a manageable range and make informed choices about your financial health. To determine your housing expense ratio, add up all monthly housing-related costs and divide this total by your gross monthly income.

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What Is a Housing Expense Ratio?

The housing expense ratio or front-end ratio is a metric used by lenders to determine a borrower’s ability to manage monthly housing costs. It comes into play when an individual applies for a mortgage .

This ratio measures the percentage of a borrower’s gross monthly income that goes toward housing expenses, including mortgage payments, property taxes , homeowners' insurance, and in some cases, homeowners' association (HOA) fees.

Understanding the housing expense ratio can help prospective homebuyers evaluate their financial readiness for homeownership. It highlights the relationship between income and housing costs and serves as a useful budgeting tool.

Calculating Your Housing Ratio

To calculate the housing expense ratio, add up all your monthly housing costs, including mortgage principal and interest, property taxes, homeowners insurance, and, if applicable, HOA fees. This total is then divided by your gross monthly income.

The formula is straightforward:

Housing Expense Ratio = Total Monthly Housing Expenses / Gross Monthly Income X 100

For example, if your total monthly housing expenses add up to $1,500 and your gross monthly income is $5,000, the calculation would be:

1500 / 5000 x 100 = 30%

This means 30% of your gross monthly income goes toward housing costs.

How Lenders Use Housing Expense Ratios

When applying for a mortgage, the housing expense ratio comes into play as part of the underwriting process . Lenders use it to assess the risk of lending to a particular borrower and prefer a ratio no higher than 28%, ensuring that borrowers can comfortably handle their housing payments.

A low housing expense ratio indicates a higher likelihood of loan approval, as it suggests the borrower has a manageable housing burden relative to their income. Conversely, a high housing expense ratio may raise red flags, prompting lenders to either deny the loan or offer it with less favorable terms, such as a higher interest rate or a requirement for private mortgage insurance (PMI).

Additionally, lenders use the housing expense ratio in conjunction with the debt-to-income (DTI) ratio, which includes all monthly debt obligations. This comprehensive evaluation helps lenders gauge overall financial health and determine an appropriate loan amount.

Housing Expense Ratio vs. Debt-to-Income Ratio

While the housing expense ratio measures the percentage of a borrower’s gross monthly income that goes toward housing expenses, the debt-to-income ratio offers a broader view of a borrower’s financial obligations.

The DTI ratio is divided into two components: the front-end ratio, which is the housing expense ratio, and the back-end ratio, which includes all other monthly debt payments like credit card bills, car loans, student loans and other personal loans. For example, if your total monthly debt payments are $2,000 and your gross monthly income is $5,000, your DTI ratio would be 40%.

Both ratios serve distinct purposes in the lending process.

• The housing ratio helps lenders evaluate whether a borrower can comfortably afford the housing costs associated with a new loan.
• The DTI ratio provides a complete picture of a borrower’s overall financial burden, helping lenders assess the risk of lending to someone who may already be carrying significant debt.
• While the housing expense ratio focuses on housing affordability, the DTI ratio is a more comprehensive measure of a borrower’s financial stability.

The 28/36 Rule

The 28/36 rule is a guideline used by lenders to evaluate a borrower’s financial health and ability to make their mortgage payments. The first part of the rule states that your housing expenses should not exceed 28% of your gross monthly income. The second part of the rule states that your DTI ratio should not exceed 36% of your gross monthly income.

By adhering to the 28/36 rule, borrowers and lenders can ensure that housing and overall debt obligations are kept within reasonable limits, promoting financial stability and reducing the risk of default

How to Lower Your Housing Expense Ratio

While increasing your income is an obvious way to lower your housing expense ratio, there are a number of other ways to reduce the percentage of your gross income going toward housing expenses.

Consider these options:

• Refinance your mortgage: Refinancing your mortgage can significantly reduce your housing expenses. By securing a lower interest rate or extending the loan term, you can lower your monthly payments, reducing your housing expense ratio.
• Rent out a part of your home: Generating rental income can offset your housing costs. Consider renting out a room, basement, or garage to bring in additional income. This extra money can be applied directly to your mortgage or other housing expenses, lowering your housing expense ratio.
• Downsize your living space: Opting for a smaller, less expensive home can dramatically lower your housing expenses. Evaluate your current needs for space and consider selling or renting out your current home to move into a more affordable property.
• Cut utility costs: Reducing utility bills can help lower your overall housing expenses. Implement energy-saving measures such as energy-efficient appliances, sealing leaks, and programmable thermostats.
• Negotiate property taxes: Appealing your property tax assessment might result in lower taxes. Research local laws and procedures to challenge an assessment if you believe your home is overvalued . Successful appeals can lead to reduced property tax bills, decreasing your housing expense ratio.
• Pay down principal: Making extra payments on your mortgage principal can reduce the overall loan balance. Over time, this strategy lowers the interest paid and can shorten the loan term, ultimately reducing your housing expense ratio.
• House hunt smarter, not harder: Move your home search to an area with more affordable homes, without HOA fees or lower real estate taxes.

Bottom Line

The housing expense ratio serves as a practical gauge for both lenders and borrowers, helping to ensure that housing costs remain manageable. By understanding and calculating this ratio, homebuyers can better prepare for homeownership, make informed financial decisions and improve their financial health. Various strategies, such as refinancing, downsizing and reducing utility costs, can help lower this ratio, making housing expenses more affordable and aligning them with long-term financial goals.

Housing Budget Tips

• If you’re looking to purchase a home, it’s important that you set a realistic budget and stick to it as best you can. SmartAsset has a calculator designed to help you determine how much house you can afford . We also have mortgage calculator that can show you how much your monthly housing payment could be and how much you’ll spend in total over the life of the loan.
• A financial advisor can help you plan for major purchases, like a home. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now .

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