In real estate, the housing ratio has been a vital aspect that needs to be carefully considered. This is typically utilized to evaluate borrowers’ eligibility for a mortgage loan based on their creditworthiness. So, let’s figure out how to calculate housing ratio?
What is the housing ratio?
This ratio compares housing costs (rent or mortgage) to pre-tax income. Lenders often use it when selecting borrowers for a loan to determine whether a potential borrower can afford the monthly mortgage payment without having to take on additional debt.
However, this comes into play when lenders decide whether a person qualifies for a mortgage. In addition, it compares housing costs to pre-tax profit or pre-tax income. Nevertheless, lenders often use this ratio in their credit analysis. In other words, lenders such as banks use the ratio during due diligence when qualifying a borrower for a loan.
The housing ratio is mainly used in mortgage loans. In addition, lenders make a full assessment of the creditworthiness of the borrower. Therefore, making sure that they will be able to pay off his massive mortgage debt.
In combination with the debt-to-income ratio (DTI) and determining the maximum amount of credit available to the borrower, firms use this ratio.
Classification of housing markets according to the criterion of affordability
Depending on the coefficient, markets are classified according to the degree of availability of housing. World practice shows that an indicator that does not exceed three years is considered optimal.
The classification itself looks like this:
- up to three years — housing is available
- from three to four years — housing is not entirely affordable
- from four to five — buying a home is seriously complicated
- from five and above — housing is significantly inaccessible
In world practice, the housing price-to-income ratio is used to assess housing affordability, which is calculated as the ratio of the average cost of housing to the average household income for the year. The value of this indicator corresponds to the number of years during which a family can save up for a house. Assuming that all cash income received will be set aside to purchase an apartment. In the United States or within the framework of the UN housing program, the values of the average market price of housing and the average annual household income are used when calculating this indicator.
How to calculate the housing coefficient?
To calculate the housing expense ratio, lenders add all of the borrower’s housing expense obligations. However, these liabilities represent operating expenses such as future principal mortgage and interest expenses, monthly utilities, etc. In addition, the borrower then divides the amount by the borrower’s pre-tax income to obtain a housing expense ratio.
It is important to note that you can calculate the housing cost ratio using both monthly and yearly payments.
Income housing coefficient
It’s an excellent and relevant measurement of home valuation and affordability.
However, when buying an asset, you have to make two significant decisions:
It would help to determine the value of the asset you are buying. However, when purchasing, you can make this measurement using a price-to-earnings or P/E ratio. This is how much is paid out for every dollar of income generated from an asset. Also, the higher the P/E ratio, the more expensive the asset. The value paid can be considered fair if the asset’s value is expected to rise faster in the future than the value of assets with a lower P/E ratio.
How can you finance the purchase of this asset? For an acquisition, this may be new capital through issuing shares. Measurements can take years to pay off based on cash flow or a contribution to earnings after funding costs.
In order to make a sound financing decision, a potential homeowner will need to weigh the percentage of financing costs against their family’s income.
However, the more years of family income that must be invested to buy a home, the lower its affordability. In this case, the family should redirect most of their income to pay for housing, rather than saving or investing in other financial assets. This is because, after accounting for inflation, the cost of housing has risen faster than income over the past few years, making homeownership less affordable.
Housing coefficient calculator
When it comes to housing ratio calculator, lenders use two ratios to approve the amount they will lend you:
- housing ratio
- debt to income ratio
The housing ratio is measured by dividing monthly housing expenses by gross monthly income. However, it should not exceed 28%. The housing ratio formula is total housing costs divided by pre-tax income multiplied by 100.
What is the 28/36 rule, and how does it affect your credit?
According to the 28/36 rule:
- 28 is your housing cost ratio
- 36 is your DTI, or debt-to-income ratio
When used together, the housing cost ratio is referred to as the “start ratio” and the DTI ratio as the “end ratio.”
If your housing expense ratio only includes housing costs, your DTI takes into account debts such as auto loans, student loans, and credit cards. If more than 36% of your income is spent on debt repayment, you are likely to have difficulty paying off your mortgage debt.
Paying off high-interest loans, such as credit card balances, will lower your current debt-to-income ratio, or DTI, which is one of the biggest factors considered when getting a mortgage.
How to calculate housing ratio? Conclusion
The housing cost ratio, or home-to-income ratio, is a quick way for you and your lender to determine how much housing you can afford. Also, consider how you can improve your situation. Before applying for a loan, you have the opportunity to work on your credit history.
If you have any questions on the way to buying a house — ask us. Sign up for a consultation and LBС Mortgage experts will be able to find the perfect financing for you.
We have been providing mortgage financing to our clients for almost 20 years and we are very confident that we can find the right mortgage solution for any and every client. The main thing is the desire to buy a dream home!