Mortgages Analyzed
Mortgages Analyzed
Mortgages Analyzed
 
Housing Ratio (Front-end Ratio)

What is Housing Ratio?

Housing Ratio (Front-end Ratio)

Housing Ratio is the monthly mortgage obligation amount expressed as a percentage of gross monthly income. It reflects the proportion of borrower’s income that is dedicated towards housing related payments.

The purpose of housing ratio is to assess the availability of income to meet loan repayment. Borrower’s income is the primary source of repayment from which the borrower makes monthly payment. In the event the borrower losses the income, then the lender falls back on the collateral (foreclosure process).

Housing Ratio is calculated by dividing the monthly mortgage obligation by gross monthly income. Monthly mortgage obligation includes monthly mortgage payment, property taxes, and insurance. Monthly mortgage obligation is also known as PITI, which stands for principal, interest, taxes, and insurance. Monthly payment includes the payment for principal and interest. Insurance includes premium for homeowner’s insurance and private mortgage insurance (PMI). PITI also includes homeowners association fee, condominium fee, and coop fee. Gross monthly income refers to income before taxes.

Housing ratio is also known as the front-end ratio and housing expense ratio.

Source :www.MortgagesAnalyzed.com

Housing Ratio is a Measure of Risk

Lenders use housing ratio as a measure of risk. Housing ratio measures the proportion of income that is available for meeting the mortgage obligation. The higher the housing ratio, the higher is the risk the borrower may default on the loan. With lower housing ratio the borrower has greater ability to meet unexpected decline in income. Also, the borrower may also use surplus cash flow to maintain and build reserves that may be used to meet temporary decline in income.

Lenders usually cap the maximum housing ratio that they are willing to lend up to. Some lenders limit loans with a maximum housing ratio of 28%, while others may allow higher with greater credit requirements such as higher credit score or lower LTV.

Housing ratio is not used in isolation. Debt to Income Ratio (DTI) is used along with housing ratio to determine the ability of the borrower to meet monthly debt obligations. Lenders also use additional risk indicators such as LTV, CLTV, and credit score, to assess the overall level of risk.

Source :www.MortgagesAnalyzed.com

Formula for Housing Ratio

Housing ratio is calculated by dividing the monthly mortgage obligation by gross monthly income. It can be expressed using the formula below.

Housing Ratio =  
Monthly Mortgage Obligation Gross Monthly Income

Since monthly mortgage obligation (PITI) equals monthly mortgage payment, property taxes, and insurance, the above can be written as:

Housing Ratio =  
(Principal + Interest + Taxes + PMI) Gross Monthly Income

Or,

HR =  
PITI Y
HR  =  Housing Ratio
PITI  =  Principal + Interest + Taxes + PMI
Y  =  Gross Monthly Income
Source :www.MortgagesAnalyzed.com

Examples for Housing Ratio Calculations

Example 1: Fully Amortizing Loan

Roland obtains a 30 year fully amortizing loan for $75,000 at an interest rate of 6% per annum. Roland’s monthly income is $3,000. The property taxes are 1% per annum. The property insurance premium per annum is $480.

In this case,

Gross Monthly Income (Y)  =  $3,000
Monthly Payment (P&I)  =  $449.66
Monthly Property Taxes(T)  =  1% × 75,000 = $62.50
Monthly Insurance Premium (I)  =  480/12 = $40
PITI  =  449.66 + 62.50 + 40 = $552.16

Housing Ratio =
PITI Y
=
552.16 3,000
= 18.41%
Source :www.MortgagesAnalyzed.com

Example 2: Fully Amortizing Loan with PMI

Roland obtains a 30 year fully amortizing loan for $75,000 at an interest rate of 6% per annum. Roland’s monthly income is $3,000. The property taxes are 1% per annum. The property insurance premium per annum is $480. Roland has to pay $25.25 as monthly premium for PMI.

In this case,

Gross Monthly Income (Y)  =  $3,000
Monthly Payment (P&I)  =  $449.66
Monthly Property Taxes(T)  =  1% × 75,000 = $62.50
Monthly Insurance Premium (I)  =  (480/12) + 25.25 = $65.25
PITI  =  449.66 + 62.50 + 65.25 = $577.41

Housing Ratio =
PITI Y
=
577.41 3,000
= 19.25%
Source :www.MortgagesAnalyzed.com

Example 3: Calculating Maximum Loan Amount Using Housing Ratio

Roland wants to obtain a 30 year fully amortizing loan at an interest rate of 6% per annum. The lender provides loans with a maximum housing ratio of 28%. Roland’s monthly income is $3,000. The property taxes are $1,200 per annum. The property insurance premium is $480. What is the maximum amount that Roland can borrow?

In this case,

Gross Monthly Income (Y)  =  $3,000
Monthly Property Taxes(T)  =  1200/12 = $100
Monthly Insurance Premium (I)  =  480/12 = $40
Periodic interest rate (i)  =  6%/12 = 0.005
Number of periods (n)  =  12 × 30 = 360
Housing Ratio (HR)  =  28%

Maximum monthly obligation = Y × HR = 3000 × 28% = $840

Max monthly payment (P&I) = 840 - 40 - 100 = $700

Monthly Payment (P&I) =
[ P × i × (1+i)^n ] [ (1+i)^n – 1 ]

Solving for P, maximum principal loan amount = $116,754.13

This is a simple example that shows how much Roland can borrower based on lenders guidelines for housing ratio. Typically, the affordability calculator is performed by using both housing ratio and debt-to-income ratio. Use the Affordability Calculator for your loan scenario to determine the maximum loan amount.

Source :www.MortgagesAnalyzed.com
 

Example 4: Calculating Maximum Loan Amount Using DTI and Housing Ratio

Roland wants to obtain a 30 year fully amortizing loan at an interest rate of 6% per annum. The lender provides loans with a maximum housing ratio of 28% and maximum DTI of 36%. Roland’s monthly income is $3,000. The property taxes are $1,200 per annum. The property insurance premium is $480. His monthly payment for credit card loan is $80. What is the maximum amount that Roland can borrow?

In this case,

Gross Monthly Income (Y)  =  $3,000
Monthly Property Taxes(T)  =  1200/12 = $100
Monthly Insurance Premium (I)  =  480/12 = $40
Periodic interest rate (i)  =  6%/12 = 0.005
Number of periods (n)  =  12 × 30 = 360
Housing Ratio (HR)  =  28%
Debt To Income Ratio (DTI)  =  36%

Based on Housing Ratio

Maximum monthly obligation = Y × HR = 3000 × 28% = $840

Max monthly payment (P&I) = 840 - 40 - 100 = $700

Monthly Payment (P&I) =
[ P × i × (1+i)^n ] [ (1+i)^n – 1 ]

Solving for P, maximum principal = $116,754.13

Based on DTI

Maximum Debt Obligation = Y × DTI = 3000 × 36% = $1,080

Max monthly payment (P&I) = 1080 - 40 - 100 -80 = $960

Monthly Payment (P&I) =
[ P × i × (1+i)^n ] [ (1+i)^n – 1 ]

Solving for P, maximum principal = $160,119.95

Lower of maximum loan amount = $116,754.13

The maximum loan amount calculated using housing ratio is lower than the amount calculated using DTI. Therefore, Roland can obtain a loan with maximum loan amount of $116,754.13.

Source :www.MortgagesAnalyzed.com

Updated: Nov 24, 2013

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It reflects the proportion of borrower’s income that is dedicated towards housing related payments
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