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 in the underwriting process for a mortgage loan.

Understanding Total Housing Expense

A mortgage cost is largely made up of loan interest and principal payments. Some mortgages also have escrow accounts that pay out property taxes and mortgage insurance (PMI). However, other ongoing home expenses must be factored into affording a home.

Total housing expenses can encompass a wide range of costs including bills, utilities, insurance premiums, and taxes in addition to direct mortgage costs. A borrower’s total housing expenses are typically required in a credit application for a mortgage loan. These expenses are measured by the borrower’s total housing expense ratio. Mortgage loan underwriters will also require that a borrower provide details on their total debt, which is measured by a borrower’s debt-to-income ratio.

Mortgage Loan Qualifying Ratios

The total housing expense ratio is one of two qualifying ratios commonly analyzed by an underwriter in the approval process for a mortgage loan. Some lenders will focus just on a borrower’s mortgage principal and interest payments while others may require a broad analysis of housing costs. 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 housing expense ratio divides a borrower’s total housing expenses by their monthly income. This ratio must typically be approximately 28% or less for approval. It is also known as the front-end ratio.

Debt-to-income is a second qualifying ratio that is also considered in conjunction with a housing expense ratio when determining approval for a mortgage loan. This ratio is known as the back-end ratio. Debt-to-income ratios divide a borrower’s total debt service, including housing debt and all other debt by a borrower’s monthly income. This ratio must generally be approximately 36% or less for approval. In some cases, higher debt-to-income levels may be allowed for mortgage loans sponsored by government agencies. Agencies can 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.

Mortgage lenders will also typically factor in a loan-to-value ratio based on the risks determined in the credit underwriting and property approval analysis. The loan-to-value ratio will also influence the maximum principal offered and the down payment required by the borrower.