Home Affordability

Home affordability is a crucial aspect of the home buying process, and it is primarily determined by three key financial metrics: loan-to-value ratio, debt-to-income ratio, and housing ratio.

  • Loan-to-Value (LTV) Ratio: This ratio compares the mortgage loan amount to the home's value. Lenders use the LTV ratio to assess the risk of the loan. A lower LTV ratio is preferred as it indicates a larger down payment, reducing the lender's risk. A lower LTV ratio can lead to more favorable loan terms, including lower interest rates.
  • Debt-to-Income (DTI) Ratio: This ratio measures an individual's monthly debt payments compared to their gross monthly income. It includes all debt payments, such as car loans, student loans, and credit card payments, in addition to the prospective mortgage payment. Lenders use the DTI ratio to evaluate a borrower's ability to manage monthly payments and repay debts. A lower DTI ratio is preferred, indicating that a smaller portion of the individual's income is committed to debt, suggesting more capacity to take on a mortgage.
  • Housing Ratio (or Front-End Ratio): The housing ratio, or front-end ratio, actively considers the percentage of an individual's gross monthly income spent on housing-related expenses, including mortgage payments, property taxes, homeowner's insurance, and homeowner association fees. Lenders use this ratio to determine the proportion of a borrower's income allocated to housing. A lower housing ratio, indicating manageable housing-related expenses relative to income, is generally viewed more favorably.

When lenders evaluate a mortgage application, they consider these ratios together to determine the home value and mortgage amount the buyer can afford. Based on the down payment, the LTV ratio sets a baseline for the maximum home value. The DTI and housing ratios refine this value by considering the buyer's income and existing debt, ultimately determining the most appropriate and sustainable mortgage amount for the prospective homeowner. This comprehensive evaluation helps lenders minimize risk while ensuring buyers do not overextend their financial capabilities.

Turning on "Power Mode" will display the results of the calculations alongside the input fields. When "Power Mode" is off, descriptive information sits alongside the input fields for a more informative learning experience.
Buyer Information
$
Monthly income is the amount your household earns each month. If you are single, this will be your individual monthly income, but if you are married, this will include you and your partner.
$
Monthly expenses are the payments made for your household day to day expenses, such as food, clothing, and entertainment, as well as debt obligations, such as auto loans, student loans, and credit cards.
Loan Information
Loan term (years) is the length of time you have to repay your mortgage, in years.
%
Interest rate is the annual percentage rate of your loan balance charged each month as interest on your mortgage.
$
Down payment is the amount of cash you will provide to your lender to make your home purchase.
$
Annual property taxes is the annual amount paid to your local government to help fund services such as schools, police, fire, public works, parks, and infrastructure.
$
Annual home insurance is the annual amount paid to your insurance company to financially protect you from damages to your property.
Lending Ratios
%
Loan-to-value ratio is a financial metric used by lenders to show what percentage of your property value is being given as a loan. A higher loan-to-value ratio suggests greater risk to the lender. Commonly, lenders require borrowers to buy private mortgage insurance if the loan-to-value ratio is above a certain percentage. Increase your loan-to-value ratio if your property can be purchased with a smaller down payment.
%
Housing ratio is the percent of your monthly income that is paid towards housing costs. Lenders use this metric to calculate the affordability of a loan for a borrower.
%
Debt-to-income ratio is a financial metric used by lenders to evaluate a borrower's ability to make monthly mortgage payment obligations. It is calculated by dividing your monthly income by your monthly debt payments. Increase your debt-to-income ratio threshold if your lender allows you to take on more debt as a percentage of your income.

Printer-friendly version

Monthly Payment Information

Home Affordability by Lending Ratios
Lending Ratio Purchase Price
Loan to Value Ratio
Housing Ratio
Debt Ratio

Prospective homeowners looking to improve their ability to afford a home, particularly concerning the loan-to-value (LTV), debt-to-income (DTI), and housing ratio, can take several steps:

  • Increase Down Payment (Improving LTV Ratio): A larger down payment reduces the LTV ratio, which can lead to more favorable loan terms, including lower interest rates. Saving more money for a down payment decreases the amount borrowed. It opens up a wider range of homes that fit the buyer's budget.
  • Pay Down Existing Debt (Reducing DTI Ratio): Lowering overall debt improves the DTI ratio. Prospective homeowners can focus on paying off high-interest debts, such as credit card balances, student loans, or car loans. A lower DTI ratio indicates to lenders that a larger portion of the individual's income is available for a home mortgage.
  • Increase Income: While not always immediately feasible, increasing income can significantly improve both the DTI and housing ratios. It can be achieved through career advancement, obtaining additional part-time work, or exploring other sources of income like freelancing or renting out a property.
  • Manage and Reduce Non-Essential Spending: By cutting back on non-essential spending, individuals can allocate more funds towards saving for a down payment or reducing debt. Creating and adhering to a strict budget can be a valuable tool in this process.
  • Choose a More Affordable Home: Adjusting expectations about the type and location of a home can also help. Opting for a less expensive property can improve the LTV ratio and ensure that the housing costs remain a manageable portion of the buyer's income.
  • Consider Different Mortgage Products: Some mortgage products are specifically designed for buyers with smaller down payments or higher DTI ratios. For instance, government-backed loans like FHA loans often have more lenient requirements.
  • Improve Credit Score: A higher credit score can lead to better mortgage terms, including lower interest rates, which directly impact the affordability of a home. Paying bills on time, reducing overall debt, and avoiding new credit inquiries can help improve a credit score.
  • Explore Assistance Programs: First-time homebuyer programs, grants, and other assistance programs can provide financial aid or favorable terms, making homeownership more accessible.

By focusing on these strategies, prospective homeowners can position themselves more favorably in the eyes of lenders, potentially increasing their ability to afford a home that meets their needs and preferences.