Total Housing Expense: Overview, How to Calculate Ratios

What Is Total Housing Expense?

Total housing expense is the sum of a homeowner's monthly mortgage principal and interest payments plus any other monthly expenses associated with their home such as insurance, taxes or utilities. Total housing expense is a key component in the calculation of a borrower’s housing expense ratio, which is used by lenders to determine whether a borrower qualifies for a mortgage loan.

Understanding Total Housing Expense

Total housing expense represents the total costs that go into the monthly costs of a mortgage loan. Typically, total housing expense includes:

• The mortgage payment
• Homeowners' insurance premiums
• Property taxes
• The mortgage insurance premium (PMI), which gets charged monthly if a borrower made less than a 20% down payment when purchasing the home.

Some lenders include bills and utilities in their calculation of total housing expenses. A borrower’s total housing expenses are typically required in a credit application for a mortgage loan. These expenses are used in calculating the borrower’s total housing expense ratio, which is the percentage of monthly gross income that goes to paying total housing expenses.

Mortgage Loan Qualifying Ratios

Some lenders may focus on a borrower’s mortgage principal and interest payments while others may require a broad analysis of housing costs. Total housing expense is used in one of the two key financial ratios used by mortgage lenders to determine whether a borrower can afford a home.

Total Housing Expense Ratio

For a borrower, housing costs will include the principal and interest on a mortgage. It may also include a variety of other items such as insurance premiums, property taxes, and homeowner's association fees. The total housing expense ratio is one of two qualifying ratios commonly analyzed by an underwriter in the approval process for a mortgage loan.

The housing expense ratio divides a borrower’s total housing expenses by their gross monthly income, which is your income before taxes have been deducted. A ratio of approximately 28% or less is usually ideal to be considered for approval. The housing expense ratio is also known as the front-end ratio.

Example of Housing Expense Ratio

Let's say that a borrower's total monthly gross income was $7,500 and the monthly housing expenses were as follows:

• The mortgage payment: $1,500
• Homeowners' insurance premiums: $150
• Property taxes: $300
• Mortgage insurance premium (PMI): $90

When adding up the monthly expenses, the total housing expense equals $2,040.

Next, we divide $2,040 by $7,500 (gross monthly income), which equals .27 or 27% when converted to a percentage by multiplying the decimal by 100.

In other words, the borrower has a housing expenses ratio of 27%, which is less than the 28% threshold usually used by mortgage lenders.

Debt-to-income Ratio

Mortgage lenders will also require that a borrower provide details on their total debt, which is measured by a borrower’s debt-to-income ratio. Debt-to-income is usually considered along with the housing expense ratio when determining approval for a mortgage loan.

The debt-to-income ratio, also known as the back-end ratio, divides a borrower’s total monthly debt servicing cost by a borrower’s gross monthly income. The debt-to-income ratio includes payments to student loans, auto loans, and credit cards.

Typically, a debt-to-income ratio of 36% or less is ideal for approval. In some cases, higher debt-to-income levels may be allowed for mortgage loans sponsored by government agencies. In some cases, agencies might allow debt-to-income ratios on mortgage loans of approximately 50% or less.

Mortgage loan underwriters use qualifying ratios for approvals and also for determining principal amounts. If approved for a mortgage loan, a lender will consider a borrower’s housing expense ratio and debt-to-income ratio capacity in determining the maximum amount they are willing to lend.

Loan-to-value Ratio

Mortgage lenders will also typically factor in a loan-to-value ratio (LTV) based on the risks determined in the credit underwriting and property approval analysis. The LTV is the percentage that the mortgage loan represents of the home's appraised value.

For example, if the mortgage loan is $300,000 and the home's value is $350,000, the loan-to-value ratio equals 86% ($300,000 ÷ $350,000 = .857 x 100 or 86%).

Some lenders might require an 80% LTV, meaning the borrower must put own a 20% down payment. The loan-to-value ratio can vary between lenders but will influence the maximum principal offered and the down payment required from the borrower.

The Bottom Line

Your total housing expense is calculated by adding up all of your monthly housing expenses, including the mortgage payments, insurance, and taxes. Mortgage lenders also use total housing expense when calculating the housing expense ratio, which is the percentage of your gross income that goes to your total monthly housing expenses. By understanding your total housing expense, you can properly budget your income and all of your expenses to ensure you can afford the cost of purchasing a home.