How the Mortgage to Income Ratio is Determined

The Federal Housing Administration, better known as FHA, is part of the United States Department of Housing and Urban Development, which is better known as HUD. The FHA is the largest insurer of mortgages anywhere in the world and has been a vital component of the economy's recovery from the housing bubble and subsequent banking crisis. The FHA insures mortgages loans made by FHA-approved lenders. This insurance removes the potential liability of default from the equation for banks and other lenders.

Certain requirements must be met in order for a loan to qualify for FHA mortgage insurance. These requirements include things like maximum loan size and maximum loan to value ratios depending upon the program used. Another factor required to qualify for most FHA loans is passing two debt ratio tests that help make sure people are not buying "too much home" for their particular financial situation, as well as make it less likely the government will have to payout on the insurance policy it issues on a mortgage.

The first of these ratios is commonly known as the Income Ratio, or occasionally, as the Mortgage to Income Ratio. To understand how the mortgage to income ratio is determined and why, one needs to take a look at how mortgages generally fit into the personal finances of homebuyers.

What Is Mortgage to Income Ratio, then anyway?

The mortgage payment is often the largest single item in a family's budget. Being able to make the mortgage payment ensures families are not disrupted by foreclosure and eviction from their home. Furthermore, if the largest budget item in a month can be met, then it is more likely that additional items can be paid on-time as well. To help make sure this is the case for buyers getting an FHA-approved loan, the maximum allowable mortgage to income ratio is 29 percent.

Calculating the ratio of mortgage payment expense to effective income is relatively straightforward, once you know which things to include and which to leave out.

First, calculate the total mortgage payment. This number should include principal and interest, payments to escrow accounts used for paying taxes, and required homeowners association dues or other mandated assessments. In addition, mortgage insurance premiums are included in the total mortgage payment as a monthly expense regardless of how the premiums are actually paid.

Once the total mortgage payment has been calculated, divide that number by the gross monthly income of the borrower. In case of a joint mortgage, the income of both borrowers is added together.

The resulting percentage is the mortgage payment to income ratio.

Although FHA insured loans require the ratio to be less than 29 percent, private lenders are free to set their own maximum ratios, or to use different ratios altogether.

Most financial planners and budget counselors recommend keeping monthly housing payments below 30 percent of income, so the maximum FHA ratio is not only a requirement for many loans, but a good rule of thumb for how high your mortgage payment should be.

Avoiding misleading websites is always a tricky proposition. When it comes to government programs, it is made all the more difficult by the reluctance of government agencies to take on private businesses for whatever reason and the fact that people are just very used to ending website names with .com.

However, governemental program websites and official government agency websites almost always end in .gov. Always check for the existence of a dot-gov website first. For example, the website fha.com looks and sounds very much like a website maintained by the FHA. However, closer inspection reveals that this is not the case.

The real FHA website can be found at http://portal.hud.gov/portal/page/portal/HUD/federal_housing_administration